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TWEEDY, BROWNE COMPANY L.P.
What Has Worked in Investing
(continued from preceding
page)
In Tweedy, Browne's experience, stocks selling at low prices in relation to earnings are also often significantly undervalued in relation to specific appraisals of the value that shareholders would receive in a sale of the entire company, based upon valuations of similar businesses in corporate transactions. Companies with low price/earnings ratios are also frequently priced at low price to book value ratios relative to other companies in the same industry.
Stocks of companies selling at low price/earnings ratios often have above average cash dividend yields. Additionally, the remaining part of earnings after the payment of cash dividends; i.e., retained earnings, are reinvested in the business for the benefit of the shareholders. Retained earnings increase the net assets, or stockholders' equity, of a company. The increase in stockholders' equity from retained earnings often equates to a specific increase in the true corporate value of a company, especially when the retained earnings result in a similar increase in a company's cash or a decrease in its debt. Reinvestment of retained earnings in business assets and projects which earn high returns can increase true corporate value by amounts exceeding the actual retained earnings. A company with a low price/earnings ratio, by definition, must provide the investor with either an above average cash dividend yield, or an above average retained earnings yield, or both.
Similar to stocks selling at low prices in relation to net current asset value and book value, the shares of a company with a low price/earnings ratio are often accumulated by the officers and directors, or by the company itself. The company's stock price has frequently declined significantly.
Benjamin Graham's Low Price/Earnings Ratio Stock Selection Criteria
Henry Oppenheimer, in "A Test of Ben Graham's Stock Selection Criteria", Financial Analysts Journal, September-October, 1984, examined the investment performance of the low price/earnings ratio stock selection criteria developed by Benjamin Graham. Benjamin Graham's stock selection criteria called for the purchase of securities of companies in which the earnings yield (i.e., the reciprocal of the price/earnings ratio) was at least twice the AAA bond yield, and the company's total debt (i.e., current liabilities and long-term debt) was less than its book value. Graham also advised that each security which met the selection criteria be held for either two years, or until 50% price appreciation occurred, whichever came first.
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