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Invest Like Graham With This Infrastructure Stock

Editor's note: This was originally published on RealMoney. It is being republished as a bonus for readers.

These daily ranges in the market are enough to cause the most ADD-afflicted among us to blanch at the constant changes. The symbols flash across the screen in red and green like the most manic video game ever invented. At times it looks like a Christmas tree with those fast-blinking bulbs that my kids always want me to choose over my more staid selection of white lights.

It looks like it is going to take the stock market some time to find a level it is comfortable with, and until then, volatility is going to be the word of the day. Several of the smartest guys in the business have been hit hard by the current gyrations, with several knocked out of the game; my focus right now is on not joining that august list.

At times like this I try to focus on market history and the basics of investing. I find myself reading the old books and old stories to reinforce my thoughts and actions. Recently I have been reading the new Warren Buffett book, and the recollections and stories about Benjamin Graham sent me back to cluttered bookshelves to reread the thoughts of the Dean of Wall Street. Naturally I have several copies of Security Analysis lying around -- you can't own just one edition! -- and The Intelligent Investor.

This time, though, I reached all the way to the back and pulled out a copy of The Undiscovered Benjamin Graham by Janet Lowe. It is a great collection of Graham articles and interviews. In an article that seems particularly accurate today, a 1974 piece in Institutional Investor contains a comment from Graham from a time similar to where we find ourselves today. Upon attending an investment conference by DLJ, Graham described the money managers in attendance as prisoners of their operations. They were promising to make above-average returns regardless of market conditions on the large pools of capital they controlled, something Graham considered not practical to achieve. Seems like the hedge funds of today to me.

Another chapter contained comments Graham made to the Medical Economist in 1976. Graham told the interviewer that he had been testing a method for selecting cheap stocks that had a margin of safety as well as potential for gains. Apparently, Graham had a lot of time on his hands in retirement, as he had tested these methods over 20 years and found they doubled the market return. I did a quick and dirty backtest today and found similar results for the past 20 years.

The method was simple: He wanted an earnings yield twice that of the AAA bond but never more than 10 times earnings. As a financial test, the company should own twice what it owes. With AAA bond yields around 5.5%, this equates to a max P/E ratio of 9 times earnings. After adding the equity and debt constraints I found 205 stocks that fit the criteria.
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