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Learning from Warren Buffett's Teacher

By Michael Carr   |   Wednesday, 23 Apr 2008 01:32 PM

The greatest influence on the investment style of Warren Buffett was Benjamin Graham, widely considered to be the originator of value investing.

In 1934, Graham literally wrote the book on value investing when he published "Security Analysis" with David Dodd.

After reading the book, Buffett enrolled at Columbia Business School and studied under Graham. Other students included legendary value investors William Ruane, Walter J. Schloss, and Charles Brandes.

Graham had a great deal of success as an investor, buying many stocks at what he considered bargain prices during the Great Depression. This disciplined investment approach continued to deliver profits throughout his life.

Graham was often able to buy stocks that traded for less than the amount of cash the company had in the bank. Such bargains are rare in today's market and usually only occur as a company plummets into bankruptcy.

But, Graham's principles are still sound and the master investor's criteria are quite simple. For this Ben Graham Superstar Screen, we looked for:

• A price-to-earnings ratio less than 25 based on earnings over the past 12 months and the forecast for the current fiscal year. This high level is appropriate in today's market given the yields on long-term Treasury bonds • A price-to-book ratio less than 1, a criteria Graham strongly advocated in all his writings

• A positive dividend yield, ensuring we are paid to wait until the market recognizes the value of the stock

• Stronger performance than the overall market, as measured by the S&P 500. This requirement is added to help us avoid the value trap of buying stocks on their way down

Interestingly, the resulting screen includes several insurance companies:

Allied World Assurance Holdings (AWH)

This insurance company with consistent earnings in excess of $7 per share recently traded near 42 a share, giving it a P/E ratio of 6 based on last year's earnings and next year's forecast. There are no balance sheet concerns in analyst reports on AWH.

Aspen Insurance Holdings (AHL)

Insurer with small subprime exposure had its stock punished at the beginning of the meltdown. A favorite of value mutual fund families like Royce and Franklin-Templeton. Recent price: 27.30.

Braskem (BAK)

Brazilian chemical company with more than $8 billion in annual sales. Offers a 4.6 percent dividend at a recent price of 16.59 and will grow as the world's economy picks up.

Endurance Specialty Holdings (ENH)

Hedge fund investor Richard Perry owns 11 percent of this insurer. Largely unknown, Perry manages $15 billion and is reported to be among the highest paid hedge fund managers, earning $350 million last year. ENH traded recently at 37.59.

FreeSeas (FREE)

At a recent price of 7, this Greek shipping company trades at only 4 times next year's estimated earnings. The high level of institutional ownership has held price gains back recently, but on the upside, institutions have become more active in unlocking value.

Grupo Aeroportuario del Pacifico (PAC)

This company operates airports, mainly in Mexico. Analysts estimate it will deliver a 50 percent total return over the next two years based upon its recent price of 42.98.

Norsk Hydro (NHYDY)

This Norwegian aluminum company is a bet on a worldwide economic recovery. With a P/E ratio of 8, NHYDY is priced at half the industry average. Trading near 14.55 recently.

PartnerRe (PRE)

This reinsurer has grown earnings at a rate of more than 22 percent a year over the past 5 years. Although earnings growth is expected to slow dramatically, at a recent price of 75.13 that slowdown is priced into the stock.

Platinum Underwriters Holdings (PTP)

With better-than-average operating margins and return on equity, this well-managed reinsurance company is priced below its peers. Its P/E ratio is only 7 at a recent price of 33.75, providing a margin of safety to conservative investors.

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MichaelCarr
The greatest influence on the investment style of Warren Buffett was Benjamin Graham, widely considered to be the originator of value investing. In 1934, Graham literally wrote the book on value investing when he published "Security Analysis" with David Dodd. After reading...
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