Guide to Benjamin Graham

Value InvestingApplying the time-tested systems developed by

“The Father of Value Investing” By J. Royden Ward, Chief Analyst, Cabot Benjamin Graham Value Investor

Table of Contents

About Benjamin Graham (1894-1976).......................................................................................3

Welcome to Cabot Benjamin Graham Value Investing ..............................................................4

About J. Royden Ward ..............................................................................................................4

Applying Benjamin Graham’s Value Strategy ............................................................................5

Intrinsic Value .........................................................................................................................5

Excerpts from The Intelligent Investor by Benjamin Graham:................................................5

Maximum Buy Price and Minimum Sell Price ........................................................................6

Cabot Value Model Portfolio ......................................................................................................7

Cabot Enterprising Model Portfolio ............................................................................................8

Weekly Updates ........................................................................................................................9

Top 275 Value Stocks ................................................................................................................9

Eight Steps to Investing ...........................................................................................................10

About Cabot.............................................................................................................................12

About Benjamin Graham1894-1976Benjamin Graham is widely acknowledged as the father of modern security analysis and the father of value investing. His timeless books, Security Analysis and The Intelligent Investor, are considered bibles for both individual investors and Wall Street professionals.

Graham co-founded Graham-Newman, investment advisors, and is recognized as one of Wall Street’s most successful

investors. However, his reputation as the father of value investing can be dated to 1928 when he started teaching Advanced Security Analysis at Columbia University.

Graham’s classes and books were the foundation of a whole new approach to the investment industry based on principles of measuring a stock’s price versus the company’s intrinsic value and applying a margin of safety.

A pioneer in financial analysis, Graham developed resilient techniques that could be followed in any market. He popularized the examination of price-to-earnings ratios, debt-to-equity ratios, dividend records, net current assets, book values and earnings growth.

Graham taught or influenced later investment gurus including Warren Buffett, Mario Gabelli, John Neff, Michael Price, John Bogle—and yours truly, J. Royden Ward.

For more than 80 years, Benjamin Graham’s value investing approach has achieved returns of 20% per year with low risk regardless of the stock market’s ups and downs.

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Welcome to Benjamin Graham Value InvestingDear Investor,

My primary goal is to provide exceptional stock recommendations by applying the time-tested systems originally developed by Benjamin Graham. My value investment strategy is designed for long-term investors who are seeking steady, above-average returns with limited risk.

I’m a second-generation Benjamin Graham disciple and Chief Analyst of the Cabot Benjamin Graham Value Investor. I started

the advisory in 2003 to provide stock selection advice to individual investors and investment professionals based on Graham’s established and proven system.

During these years, with the help of many readers’ suggestions and supportive communications, I greatly expanded the advisory into a complete investment service.

In Cabot Benjamin Graham Value Investor, I apply Benjamin Graham’s theories of value investing to select quality stocks with the potential to safely beat the stock market indexes year after year. On the following pages, I’ll explain how you can use the Investor to achieve steady, above-average returns with low risk.

Sincerely,

J. Royden Ward, Chief AnalystCabot Benjamin Graham Value Investor

About J. Royden Ward

Roy Ward brings nearly 50 years of experience as an investment advisor, director of research and portfolio manager to Cabot Benjamin Graham Value Investor.

Roy gained extensive knowledge from his college professor, Dr. Wilson Payne, who created the Babson College finance and investment curriculum with Benjamin Graham. With the help of Dr. Payne, Roy later created software to formulate and adapt the fundamental analysis taught by Dr. Payne and Benjamin Graham.

Roy now shares his knowledge, experience and findings with subscribers of the Cabot Benjamin Graham Value Investor. The advisory has attracted thousands of subscribers around the world who have benefited from the time-tested principles of Benjamin Graham. Roy Ward’s keen utilization of value investing to find companies worth substantially more than their current stock price has helped investors choose stocks to ensure that their financial goals are consistently achieved.

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Applying Benjamin Graham’s Value Strategy

The objective of value investing is to find stocks priced incorrectly by the market. Specifically, I seek companies that are worth substantially more than their current stock prices.

After identifying high quality companies with underpriced stocks, I recommend buying and patiently holding the stocks for the long term, usually one to three years.

You should sell a stock when it becomes overvalued, that is, when the stock price is significantly more than its true worth. You will then be able to take well-earned profits when you sell your carefully selected value stock. Many investors have made fortunes using a value-based approach—Warren Buffett is the most well-known value investor.

During the past 100 years, value stocks have clearly outperformed other types of stocks the majority of the time. During 2009 to 2013, though, growth stocks outperformed value stocks*. But today, growth stocks are overvalued and the switch back to value stocks is evident. Value stocks will likely outperform growth stocks during the next decade or longer. If you want the odds in your favor, I strongly advise devoting at least 50% of your portfolio to value stocks.

Intrinsic ValuePerhaps more than any other type of investing, value investing is focused on the fundamentals of a company’s balance sheet and income statement. Fundamentals include current assets, long-term debt, earnings, dividends, cash flow and book value.

Value investing does not entail following earnings and stock price momentum, reading stock charts or timing the market.

The entire approach to value investing revolves around the intrinsic value of each company. And therein lies the problem: how do you determine the value of a company?

Excerpts from The Intelligent Investor by Benjamin Graham

“ Investment is most intelligent when it is most businesslike. It is amazing to see how many capable businessmen try to operate in Wall Street with complete disregard of all the sound principles through which they have gained success in their own undertakings.”

“ The stock of a growing company, if purchasable at a suitable price, is obviously preferable to others. No matter how enthusiastic the investor may feel about the prospects of a particular company, however, he should set a limit upon the price that he is willing to pay for such prospects.”

“ If the investor is bargain-minded he might as well be on the lookout continuously for individual bargains, instead of seeking to operate in leading stocks at widely spaced intervals or even on a sliding-scale basis as dictated by formula timing plans. Individual security bargains can be located by the process of security analysis at any time.”

*Callan Associates 2014

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Benjamin Graham, considered the father of value investing, spent many years formulating a system to determine the intrinsic value of a company. His findings are contained in two of his books: The Intelligent Investor and Security Analysis. I have converted Graham’s intrinsic value methodology into a computer-generated model. My resulting Maximum Buy Price and Minimum Sell Price estimates make investing easy: buy when a stock is selling for less than its intrinsic value (Maximum Buy Price) and sell the stock when it becomes overvalued (Minimum Sell Price). In short, buy low and sell high.

Maximum Buy Price and Minimum Sell PriceI use a lot of data to determine my Max Buy and Min Sell Prices. I purchase data from several research firms to create my own stock database. I then apply complex software programs to produce Max Buy and Min Sell prices. Here is a quick summary of the data and ratios I use:

1. Historic ratios including:• 10-year historic mean of the Price to Sales (P/S) ratio• 10-year historic mean of the Price to Cash Flow (P/CF) ratio• 10-year historic mean of the Price to Earnings (P/E) ratio• 10-year historic mean of the Price to Dividend (P/D) ratio• 10-year historic mean of the Price to Book Value (P/BV) ratio

2. The ratios of the five factors above using current data.

3. Forecast ratios for the next two years using analyst and computer-generated estimates for sales, cash flow, earnings, dividends and book value.

4. Intrinsic value using the 10-year forecast earnings per share discounted to present using 10-year Treasury yield adjusted by the quality of each company.

These data and ratios are melded into one Max Buy Price and one Min Sell Price for each stock using quantitative analysis. Max Buy Prices are accurate indications of the intrinsic value of each company and can therefore be used to determine if a company’s stock price is undervalued. Only companies with current stock prices below their intrinsic Max Buy Price values are recommended to be purchased.

Min Sell Prices indicate the optimum price to sell each stock. All stocks are recommended to be sold when their Min Sell Price is reached. Average holding period is 20 months but varies considerably from stock to stock. Stocks are recommended to be sold prematurely when financial performance falters.

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Cabot Value ModelThe Cabot Value Model recommends low-risk conservative stocks and ETFs. When the stock market is high or when the market is falling, I advise buying most of your stocks from the Cabot Value Model. If you are a conservative investor, the Value Model is the place for you to find attractive opportunities in any market conditions.

The Cabot Value Model Portfolio contains 16 undervalued stocks or ETFs (exchange-traded funds). Stocks in this model are low risk selected according to Modern Value analysis or A-List Dividend analysis. The Cabot Value Model is typically emailed to you on the first Thursday of the month.

I minimize risk in the Value Model by apportioning part of the Model to defensive, counter-cyclical stocks and ETFs. I adjust allocations based on Benjamin Graham’s bond/stock allocation rules set forth in his book, The Intelligent Investor:

When the stock market is undervalued, hold 25% bonds and 75% stocks.

When the stock market is overvalued, hold 75% bonds and 25% stocks.

I’ve modified Graham’s rule regarding the portion allocated to bonds to reflect today’s modern market. Rather than invest in bonds at record high prices, I prefer defensive, ultra-conservative stocks, laddered bond ETFs and defensive or conservative ETFs.

Modern Value AnalysisThe Modern Value analysis is a system developed by Benjamin Graham and Dr. Wilson Payne in 1946, which I later enhanced. The analysis uncovers undervalued stocks of industry-leading, high-quality companies which have produced steady earnings growth. This analysis is similar to that used by Warren Buffett. The criteria I use to find companies for the Modern portion of the Value Model are:

• Total Ratings 8.00 or above

• Quality Ratings usually above 3.00

• Standard & Poor’s Quality Ranking of B+ or higher

• One-year forward EPS growth forecast of 8% or above

• Five-year estimated EPS growth of 10% or above

A-List Dividends AnalysisA-List Dividend stocks are derived from a database of companies including the Standard & Poor’s 500 Dividend Aristocrats Index plus companies that have increased their dividends by 10% or more every year for the past 10 years. I look for companies that will provide the best chance of outperforming the stock market indexes during the next six to 12 months. The results are high-quality companies with dividend yields of 1% or more and excellent prospects for the year ahead.

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Cabot Enterprising ModelSix additional analyses are presented to you in the Cabot Enterprising Model of 16 Stocks, which is typically emailed to you on the second Thursday of the month. These choices are intended to round out your portfolio.

Most of the stocks in the Cabot Enterprising Model are moderate risk. The Model is well diversified and contains a variety of stocks. Stocks in the

Model are purchased at their current prices, rather than at or below a Maximum Buy Price, but still sold using my Minimum Sell Price.

Classic Value AnalysisClassic Value stocks are found using the “classic” approach created by Benjamin Graham. Classic stocks tend to be less well known than Modern stocks. I use Mr. Graham’s seven criteria:

• Price to earnings ratio 9.0 or less (uses latest 12-month earnings per share)

• Price to book value ratio 1.20 or less

• Long-term debt to current assets ratio 1.10 or less

• Current assets to current liabilities ratio 1.50 or more (current ratio)

• Forecast 5-year EPS growth of 1.0% or higher

• Dividend yield of 0.5% or higher

• Value Line Financial Strength Rating of B+ or higher (Graham used the Standard & Poor’s Earnings/Dividend Rank of B or higher.)

Graham-Buffett AnalysisGraham-Buffett Stocks are low-risk, blue chip-type stocks. The criteria are free cash flow over $20 million, net profit margin over 15%, return on equity over 15%, discounted cash flow higher than the current price, market capitalization over $500 million, S&P rating of B+ or better, positive earnings growth during the past five years with no deficits and current dividends.

Undervalued Canadian Companies AnalysisThese are stocks of rapidly growing companies with reasonable price-earnings ratios. I screen Value Line, Standard & Poor’s, Zacks and Investors Business Daily databases to find companies with steady, rapidly growing earnings. I also make sure that price-to-earnings ratios are reasonable and balance sheets are strong.

Net Current Asset Value AnalysisBenjamin Graham introduced this simple formula to identify “bargain stocks” 80 years age. Also called “Net-Net,” the formula is calculated by subtracting the company’s total liabilities from current assets, dividing the results by outstanding shares, and dividing the current share price by the just calculated NCAV. The resulting price to NCAV ratio is then applied to uncover “bargain stocks.”

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Undervalued Companies with Low Price-to-Book Values AnalysisStocks with low price-to-book values are typically moderate risk value stocks. The three criteria that I use to find these companies are Value Line Financial Strength Ratings of B+ or better, increasing dividend payments and price to book value ratios of companies in the lower half of their respective industry sectors. I also look for companies with good earnings prospects for the next 12-month and five-year periods.

Low PEG Ratio Analysis Stocks with low price/earnings to growth ratios (PEG) are moderate risk value stocks that tend to be volatile. The PEG ratio is calculated by dividing the current price-to-earnings ratio by the forecast five-year EPS growth rate plus diviend yield. I select companies with PEG ratios below 1.00 and with one-year EPS forecasts of 15% growth or better.

Sell AlertsWhen a Cabot Value Model or Cabot Enterprising Model stock is recommended to be sold, the change will be clearly noted in the issue and Weekly Update, and when necessary, a Sell Alert will be sent to you via email or text alert. I recommend selling a stock when any one of three conditions are met:

• The stock reaches its Minimum Sell Price.

• The company reports disappointing earnings-per-share for three straight quarters.

• The company has encountered adverse conditions that will persist longer than six months.

Weekly UpdatesEvery Friday, via email, you will receive an Update on buy and hold stocks. The Weekly Update includes the latest news, quarterly financial results and changes in my opinion (buy, hold or sell) for each company that has reported news or released earnings.

Top 275 Value Stocks DatabaseThe table of 275 Value Stocks offers you additional value stocks to meet your investment objectives. Twenty-three columns of data are provided for all companies in the Top 275 Value Stocks table, including each company’s Max Buy and Min Sell Price and my current Buy, Hold or Sell Opinion. The Top 275 is made up of stocks recommended for you to buy in previous issues of the Cabot Benjamin Graham Value Investor, companies with high Cabot Total Ratings or companies selling below their Min Sell Prices. (Stocks recommended to be sold in prior issues may not be included in the Top 275.)

The table of the Top 275 Value Stocks is included in the Cabot Value Model issue and is also available online via the Cloud, where you can view companies’ prices, dividend yields, price to earnings ratios and several other items of data in real time. The online database is also customizable, allowing you to add your own stocks and sort by all categories, such as company names, dividend yields, price-to-earnings ratios, quality ratings and Roy’s Opinion. To request access to the online Top 275 Value Stocks, write to roy@cabot.net.

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Data provided in the database includes: • Current Price to Earnings ratio (I generally recommend stocks with P/Es less than 15.0.)• Forecast 5-year Earnings-per-Share Growth (Look for growth of 10% or higher.)• Current Dividend Yield (1% of higher)• Each Stock’s Risk Rating (Medium, Low or Very Low Risk)• Quality, Value, Growth, Technical, and Overall Total Ratings (Look for high Quality Ratings in

declining markets and high Growth Ratings in advancing markets.)• My Opinion on whether to Buy, Hold, or Sell each stock (Limit your purchases to Buy stocks.

Sell stocks promptly).

The table allows you to easily find the type of stock you are seeking. For example, if you want to buy: (1) a high-quality company with (2) a long history of rising dividends, with (3) high EPS (earnings per share) growth expectations for the next five years, and with (4) the company’s stock price selling below its intrinsic value, the information is readily available for you to choose the best stocks. Please keep in mind numbers do not tell the whole story. You will need to conduct additional research on stocks you like but don’t include my Buy opinion.

Eight Steps to InvestingMy goal for the Cabot Benjamin Graham Value Investor is to provide you with exceptional stock recommendations using the techniques pioneered by Benjamin Graham. My second goal, just as important, is to give you the confidence to buy the stocks I recommend and the patience to hold them to fruition. I am confident that when I can achieve my goals, then you’ll achieve yours, and together we’ll develop a long and prosperous relationship!

Here’s a step-by-step guide to investing with the Cabot Benjamin Graham Value Investor:

1. Organize your portfolioCommit a percentage or dollar amount of your portfolio to value stocks. You should commit at least enough to accommodate investments in 10 or more of the companies recommended in the Cabot Benjamin Graham Value Investor.

2. Determine how many value stocks to buyAfter determining how much money you will invest in value stocks, you need to determine how many stocks to buy. We recommend 10 to 12 stocks for commitments under $100,000, and 25 to 35 stocks for commitments over $500,000. If your portfolio commitment is between 100,000 and 500,000, you can interpolate to get the approximate number of stocks you should own. Invest an equal dollar amount into each stock and leave 2% to 5% in cash.

3. Buy stocksI recommend waiting for each stock you choose to dip below the suggested Maximum Buy Price before buying. You may miss out on a stock or two, but it is better to move on to another stock than to buy a stock with limited potential. I recommend waiting a month for an overpriced stock to decline to my Max Buy Price before abandoning your buy order and finding another possible stock to buy.

If you are looking for conservative companies with low risk but with decent growth potential, I advise finding buy candidates in the Cabot Value Model.

If you are looking for moderate risk but higher appreciation potential, I advise finding buy candidates in the Cabot Enterprising Model. Note that Enterprising Model stocks are bought at the current price rather than the Max Buy price.

Both Models have good track records, although individual stock performance varies widely. If you are just starting your portfolio, I recommend starting with conservative Cabot Value Model stocks and then adding moderate-risk Cabot Enterprising Model stocks after you have established a solid foundation.

If a stock is selling above its Maximum Buy Price, you should consider placing a limit order with your broker to buy the stock at our Maximum Buy Price. After purchasing a stock, if the stock falls 10% or more, don’t be alarmed. I generally recommend that you consider buying additional shares at the lower price.

4. Buy a diversified selection of companies in equal amountsChoose companies that will diversify your portfolio as much as possible, limiting your investment in any industry sector to no more than 20%. Purchase your selected stocks as soon as they drop to or dip below the Maximum Buy Prices.

5. Commit your funds slowlyI recommend dollar-cost averaging when starting a new portfolio. Use a three-month time frame and invest equal amounts each month. For example, if you want to invest in a total of 15 companies, invest equal dollar amounts in five different companies in each of the next three months. If there are less than five undervalued companies available in any month, stretch out the time-frame to four months or even longer. Don’t overweight or buy overly large positions—it rarely works out well.

6. Monitor your stocks and get ready to sellMy targeted holding period is typically two years, so be ready to hold your companies for up to two years. In the interim, expect stock prices to rise and fall. Prepare to ride out the price fluctuations. Each stock should be held until it reaches its Minimum Sell Price.

7. Sell stocksWhen the Min Sell Price is reached, I will alert you in a Sell Alert and the Weekly Update. If you are unsure whether you should sell a company, send an email to roy@cabot.net and I’ll get right back to you.

8. Restock your portfolioAfter you have sold a stock, simply replace it with another stock from the current recommendations. If your sale creates excess funds, you can add to one of your smaller holdings to keep your portfolio in balance.

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Neither Cabot Heritage Corporation, nor our employees, are compensated in any way by the companies whose stocks we recommend. Sources of information are believed to be reliable, but they are in no way guaranteed to be complete or without error. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. © Cabot Heritage Corporation 2014. Copying and/or electronic transmission of this guide is a violation of the copyright law. For the protection of our subscribers, if copyright laws are violated, the subscription will be terminated. To subscribe or for information on our privacy policy, visit www.cabot.net, write to customerservice@cabot.net or call 978-745-5532.

About CabotCabot was founded in 1970 to provide honest, high-quality research and investment advice to individual investors and investment professionals. Today, the Cabot family of investment advisories continues to offer independent advice on investing in common stocks that is grounded in sensible, time-tested investment strategies and presented in a clear, readable style. We are publishers of Cabot Market Letter, Cabot Top Ten Trader, Cabot China & Emerging Markets Report, Cabot Benjamin Graham Value Investor, Cabot Small-Cap Confidential, Cabot Stock of the Month, Cabot Options Trader, Cabot Options Trader Pro, Cabot Dividend Investor and Cabot Wealth Advisory.

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