Benjamin Graham, Public-Utilities and Financial Enterprises

Banks, Insurance Companies and other stocks that don't report Current Assets and Current Liabilities can also be evaluated using the Value Investing framework of Warren Buffett's mentor.

What Graham Wrote

Graham gave the following instructions on the subject of analyzing Utilities and Financials, which are structurally different from other types of stocks.

Size and Financial Condition

"1. Adequate Size of the Enterprise... not less than $50 million of total assets for a public utility."

"2. A Sufficiently Strong Financial Condition.. For public utilities the debt should not exceed twice the stock equity (at book value)."

Chapter 14: Stock Selection for the Defensive Investor, The Intelligent Investor.

Criterion #1 above works out to about $250 million of total assets today, when adjusted for inflation.

Equity and Debt

"The Public-Utility “Solution”...We exclude one criterion from our tests of public-utility stocks—namely, the ratio of current assets to current liabilities. The working-capital factor takes care of itself in this industry as part of the continuous financing of its growth by sales of bonds and shares. We do require an adequate proportion of stock capital to debt."
Chapter 14: Stock Selection for the Defensive Investor, The Intelligent Investor.

Earnings and Book Value

"Investing in Stocks of Financial Enterprises... We have no very helpful remarks to offer in this broad area of investment—other than to counsel that the same arithmetical standards for price in relation to earnings and book value be applied to the choice of companies in these groups as we have suggested for industrial and public-utility investments."
Chapter 14: Stock Selection for the Defensive Investor, The Intelligent Investor.

Utilities and Financials are therefore evaluated using Total Assets and Equity:Debt; instead of Sales, Current Assets and Current Liabilities.

Screening

Serenity's free Classic Graham Screener follows Graham's standard Value Investing framework. The Advanced Graham Screener has additional filters which — when used in combination with the standard Graham rules — allow for the screening of Utilities and Financials.

Filter Values

Graham Ratings on Serenity are defined such that Graham's Defensive requirements default to 100%. Considering today's bond yields, a Graham Number(%) of 70% is sufficient for a Defensive grade stock to clear Graham's criteria.

The filter values on the Advanced Graham Screener for Utilities and Financials would therefore be:

Earnings Stability (100% ⇒ 10 Years): 100%
Dividend Record (100% ⇒ 20 Years): 100%
Earnings Growth (100% ⇒ 33% Growth): 100%
[2 x Equity] ÷ Debt: 100%
Size in Assets (100% ⇒ 250 Million): 100%
Graham Number(%): 70%
Source (Analyzed by): Serenity

The filter for Sectors is not included here because certain stocks which would not necessarily be classified as Utilities or Financials — such as Real Estate Investment Trusts (REITs) — also need to be screened using the above criteria.

Note: The rules for Utilities and Financials are an advanced customization of the Graham's standard Defensive rules, and so not supported by the free Classic Graham Screener.

Comments

Hello,I've been searching a month which formula should I use to test the public utilities for their financial condition. The sentence 'the debt should not exceed twice the stock equity (at book value)' is whether just pasted without explanation or said to be ambiguous. What exactly is 'debt'? 'Short-Term Debt'? 'Long-term Debt'? (the only two values containing the term 'debt' within the gurufocus definitions section). And what about 'book value': 'Tangible Book Value' or simply 'book value'? I ended up building the following formula: 0 ≤ Total Liabilities/ (Total Assets - Intangible Assets - Total Liabilities) ≤ 2 but I have doubts... I have just the feeling that no one understand it and everybody is avoiding the problem....Could you please help me to solve the problem?

Hello Francesca,

Graham always uses specific terms such as net tangible assets, Long-term debt etc wherever applicable. So it should be safe to assume that Graham means Book Value and Total Liabilities here.

The [2 x Equity] ÷ Debt rating on Serenity uses:
2 x (Total Assets - Total Liabilities) ÷ Total Liabilities

So for a Public Utility to qualify as Defensive, it would need to have:
Equity:Debt > 100%

Graham Resources