Graham believed that investors should be "wary of new issues," a belief he espoused in his must-read classic, The Intelligent Investor. Graham gave two reasons for his IPO reluctance. First, he believed that new issues had "special salesmanship behind them", which meant that someone on Wall Street was getting their pockets lined because of the deal.
Second, he believed that IPOs were sold under "favorable market conditions," meaning the seller had an advantage over the buyer. Put another way, by the time a buyer gets a hold of their shares, the easy money has already been made because issues often price at more than they are worth.
- 1. Adequate size -- Graham excluded smaller companies. I've set the minimum market cap at $1 billion.
2. Strong financial condition -- Minimum current ratio of 2; long-term debt must be less than working capital.
3. Earnings stability -- Graham required positive earnings for at least 10 consecutive years. I am using seven years.
4. Dividends -- Graham required "uninterrupted" dividends for at least 20 years. I am using seven years here as well.
5. Earnings Growth -- Graham looked for companies that increased earnings per share by at least 33% during the past 10 years. I am using a minimum compounded annual growth rate of 5% over seven years.
6. Moderate price-to-earnings ratio -- Average P/E ratios should be less than 15 during the past three years
7. Moderate ratio of price to assets -- Graham sought companies with price-to-book ratios of less than 1.5, but would accept a higher P/E ratio, if the price-to-book ratio was lower. This end result was that P/E times the price-to-book ratio should be less than 25.5.
8. Other considerations -- U.S. companies only. I excluded foreign companies and American depositary receipts (ADRs) from the results.
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