Article from Financial Post about Benjamin Graham's principles

If you are interested in a higher risk commodity play, Sherritt may be interesting to you. Too much uncertainty for me. I think that the reward:risk ratio is favourable at any rate.

Graham's metrics still apply

Stock selection narrows field to Sherritt Int.

Richard Morrison, Financial Post
Published: Friday, April 04, 2008

Bloomberg News, Kagan Mcleod, National Post
Each Friday, Richard Morrison, an editor at Financial Post and a longtime active trader, takes you through a variety of screening tools to help the individual investor find great stocks.

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Benjamin Graham, the father of modern security analysis, was a professor at Columbia University, taught Warren Buffett and wrote the most famous -- and arguably the best -- book on investing, The Intelligent Investor, first published in 1949. In a chapter on stock selection for defensive investors, he said they should look for large, dividend-paying companies with little debt and a consistent record of profitability, whose shares trade at low multiples to earnings and book value.

We applied Graham's criteria to the Canadian market, using the FP Corporate Analyzer program to identify companies Graham would likely find attractive. We found nothing. To-day's markets are much loftier than they were in Graham's day, so those seeking established companies with undervalued share prices have to loosen his requirements a bit to find any U.S.-listed bargains. Rules have to be bent even further to find a Canadian candidate.

Large-cap stocks Graham said defensive investors should avoid small companies -- something that's easier to do in the United States than in Canada. For example, there are about 1,100 companies with a market capitalization of more than $1-billion on the New York Stock Exchange, but only about 250 common stocks and income trusts larger than $1-billion on the Toronto Stock Exchange (30 of which are interlisted on the NYSE). We placed the minimum market capitalization at the $500-million mark, giving us a universe of 323 stocks.

Current ratio Graham's candidate companies had to be able to easily handle their debt payments. To that end, the current ratio--current assets to current liabilities -- had to be at least two. Long-term debt should not exceed net current assets, or working capital. We plugged that criteria into the FP Corporate Analyzer and our field of candidates dropped to 92.

Earnings growth Graham insisted his candidate companies have some earnings in each of the past 10 years and have increased their earnings by at least one-third over the same period. The requirement was too strict and turned up nothing, so we modified the search to ask for those companies whose earnings had increased by at least 1% in each of the past five years. The result was only 19 names.

Graham's further requirement that candidates have uninterrupted dividend payments for at least the past 20 years also would have left us with nothing, so we asked only that our candidate paid a dividend.

Finally, we applied two more Graham criteria to our list: a price-to-earnings ratio of no more than 15, which knocked our candidates down to seven, and a price-to-book ratio of no more than 1.5. The result? One company, Sherritt International Corp. (S/TSX).

Sherritt, best known for its activities in Cuba, has interests in nickel, cobalt, coal, and oil and gas production, is the closest we got to a company that meets Graham's criteria.

Norman Rothery, founder of the Stingy Investor Web site (stingyinvestor.com) and the Rothery Report, a newsletter that focuses on value stocks, said he would have been shocked had any Canadian company met Graham's original qualifications. "You have to make approximations to Graham's original rules to get anything at all."

Sherritt has turned up on several of his screens, Rothery said, noting the company appears in an "all-star" list of best potential investments he compiled in MoneySense magazine. Sherritt scored an A for value and a B for growth.

Despite its deep value characteristics, stock screens won't turn up such things as political risk, which must be factored into Sherritt. Sherritt has a 50% interest with the Cuban government in the Moa nickel-cobalt open pit mine in Moa Bay in eastern Cuba. Originally owned by Freeport-McMorRan Copper & Gold Inc.,Moa was confiscated by the Cuban regime in the late 1950s. Moa's sulphides are shipped to the Fort Saskatchewan nickel-cobalt refinery north of Edmonton, providing most of its nickel feed.

Sherritt is a 40% owner and operator of the US$3.3-billion Ambatovy nickel laterite project in Madagascar, where production is expected in 2010. It also has oil and gas interests in Cuba, Spain and Pakistan.

Last month, Sherritt announced a plan to acquire the 59% of the Royal Utilities Income Fund it didn't already own. The fund controls Prairie Mines & Royalty Ltd., whose eight mines in Alberta and Saskatchewan supply coal to nearby generating plants. The company also announced plans raise $400-million in capital through a bought deal.

Eight analysts follow Sherritt -- six say buy, two say hold -- but most were lukewarm to the Royal deal, and many lowered their 12-month target prices, but even the most pessimistic expect the stock to reach $17 in 12 months. One, Ray Goldie of Salman Partners, has a $27.20 target.

Company specifics aside, Graham's criteria is still worthwhile, Rothery said.

"I've been running similar defensive-type screens for the Canadian MoneySaver magazine for several years, and it's worked very well."