Benjamin Graham, Public-Utilities and Financial Enterprises

The Value Investing framework of Warren Buffett's mentor can also be used to evaluate Banks, Insurance Companies and other stocks that don't report Current Assets and Current Liabilities.

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.

Public-Utilities

"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.

Total Assets ≥ $250 Million

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

No Current Assets or Liabilities

"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.

Equity:Debt

The [2 x Equity] ÷ Debt rating on Serenity is simply a variation of of the standard Debt-To-Equity Ratio – D/E. This Graham Rating is based on Graham's recommendations for "stock equity" or "stock capital" (also a common accounting term).

The rating is simply calculated as: 2 x (Total Assets - Total Liabilities) ÷ Total Liabilities

Financial Enterprises

"Investing in Stocks of Financial Enterprises... 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.

Screening

Serenity's free Classic Graham Screener follows Graham's standard 17-rule 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.

Advanced Filters

Graham Ratings on Serenity are defined such that they're better when higher, and that Graham's Defensive requirements default to 100%. However, 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%
Analyst Serenity

Sectors

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.

Utilities and Financials can also not be included in the default Defensive grading system precisely for this reason; because their specifications cannot be applied to automatically determinable sectors.

The rules for Utilities and Financials are thus an advanced customization of the Graham's standard Defensive rules, and so only supported by the Advanced Graham Screener.

Note: Graham himself wrote that Utilities were more likely to clear his Defensive criteria, than were Industrials and other types of stocks.

Utilities and Financials are thus evaluated using Total Assets and Equity:Debt, unlike regular Defensive grade stocks.

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