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Seven International Value shares

Seven international shares have met the global value criteria based on the stockpicking approaches of three investment greats: Benjamin Graham, John Neff and David Dreman.
November 12, 2014

The trouble with cheap shares is that sometimes they're cheap for a good reason. This was the problem that my Global Value screen ran into last year. Having only managed to find five shares that fitted the criteria in 2013 (even after relaxing the screen's tests) two of the stocks selected proved to be duds. Indeed, substantial falls by both Ensco and Technip left the overall, currency-adjusted total return from the screen at a miserable negative 7.4 per cent. That compares with a positive 8.4 per cent return from the S&P Global 1200, the index from which the shares were picked (see table below).

NameCodeTotal Return (7 Nov 2013 - 4 Nov 2014)
Macy'sUS:M24.3%
Japan TobaccoJP:ABOT1.0%
SafranFR:SGM-0.1%
EnscoUS:ESV-31.1%
TechnipFR:TEC-31.2%
Average--7.4%
S&P Global 1200-8.4%

Source: Thomson Datastream

 

The torrid 12 months means the cumulative total return since I began running the screen in 2012 is now 22.1 per cent, which lags well behind the 35.5 per cent from the index (see graph).

 

Source: Thomson Datastream

 

The two villains of the piece from last year's Global Value (GV) screen both operate in the oil services market. Given the recent fall in the oil price and the likely negative repercussions for the industry's capital expenditure plans, it's perhaps not too surprising that these stocks have produced major falls. Nevertheless, after a really poor result it is always worth asking whether a screen is actually worth running again or needs some major changes.

In the case of the Global Value screen, I've actually decided to leave things pretty much unchanged and to give it another go. In no small part is this because the screen is based on the wisdom of three investors with outstanding pedigree - Benjamin Graham, John Neff and David Dreman.

The key valuation requirements of the screen come courtesy of Mr Graham and Mr Neff. The screen uses the 'intrinsic value' formula devised by Mr Graham to seek out shares trading at a discount to what the formula suggests is their true worth. In addition, it looks at a souped-up version of the price-earnings-growth ratio (PEG) that is similar to the valuation metric used by Mr Neff. The formulae are as follows:

 

Graham's intrinsic value formula:

(EPS x 8.5) + (2 x long-term EPS growth rate) x (4.4/AAA corporate bond yield)

In the above formula, 8.5 is suggested by Graham as an appropriate earnings multiple for a company showing no growth. The AAA corporate bond yield (3.17 per cent in our formula) is used to take account of the prevailing interest rate and 4.4 represents the average bond yield at the time Graham made this addition to his formula. Long-term growth rates are notoriously difficult to assess, but I've used figures calculated by S&P based on brokers' consensus long-range forecasts.

Genuine value (cash-adjusted Neff) ratio:

(EV/EBIT)/(long-term EPS growth rate + dividend yield)

Rather than using the exact valuation ratio espoused by John Neff I've used what I've termed a "genuine value ratio". This is effectively a cash-adjusted version of Mr Neff's valuation formula which uses the enterprise-value-to-operating-profit ratio where he would use PE.

 

Shares must be trading at a 50 per cent discount to intrinsic value and must be among the cheapest two-fifths of shares based on their GV ratio. In addition, the stocks must pass the following tests, several of which draw on the approach espoused by Mr Dreman for winkling out stocks that are cheap:

■ A return on equity of more than 10 per cent.

■ A current ratio (current assets/current liabilities) of more than 1.

■ Net debt of less than two times cash profits.

■ Five-year compound average annual EPS growth of 5 per cent or more.

■ Average forecast EPS growth over the next two reporting years of 5 per cent or more.

■ Five-year compound average annual dividend growth of 5 per cent or more.

■ A yield higher than the median average of all dividend-paying stocks screened.

Seven stocks passed the screen this year and, thankfully, unlike last year, I have not had to water down the criteria to get positive results. There is a preponderance of US stocks in the screen results, which means the portfolio as a whole has significant exposure to the currently strong dollar. The shares are ordered from highest to lowest discount to intrinsic value.

 

SEVEN INTERNATIONAL VALUE SHARES