Benjamin Graham is best known for having taught Warren Buffett – one of the most successful investors of recent times – and had a formidable investment track record in his own right.

He’s often called the “Father of Value Investing” because of his focus on a company’s price. That style has been out of fashion in recent years, with a focus instead on “growth companies” like

Amazon and high quality “compounders” like Unilever.

However, all that support has caused high prices for growth stocks so we thought it might be worth taking a look at some more value focused options.

In his book “The Intelligent Investor”, Graham set out some minimum criteria companies had to meet before he would consider investing. While the world has changed a great deal since Graham’s time, his book is still in print and considered something of a bible by many value investors.

At 500+ pages and having last been updated in the early 70s it’s not a light

read – we’ve outlined the bits we think are most useful for investors today. For people who can get hold of a copy and don’t have the stomach for the whole book, chapters 1, 8, 14, 15 and 20 will give you a good overview of Graham’s key ideas.

We’ve also run his rules over the 350 largest companies listed on the London Stock Exchange to see which UK companies he might be interested in today.

This factsheet isn’t personal advice. If you’re not sure if an investment is right for you please seek advice. All investments fall as well as rise in value so you could get back less than you invest.

Investing in individual companies isn’t right for everyone. Our shares to watch are for people who understand the risks of investing in equities. It’s higher-risk as your investment is dependent on the fate of that company – if a company fails you risk losing your whole investment. Investors should make sure they understand the companies they’re investing in, the company specific risks, and make sure any businesses they own are held as part of a diversified portfolio.

WOULD WARREN BUFFETT’S TEACHER BUY THESE UK SHARES TODAY?

Think like the “Father of Value Investing”

NICHOLAS HYETT Equity Analyst

IMPORTANT NOTES:

This factsheet is not personal advice or a recommendation to buy, sell or hold any investment. Unless we tell you otherwise, we won’t make any assessment of whether the investments and/or investment services you choose are appropriate or suitable for you, so you won’t have the protection of us telling you if they’re not. If investors are not sure of the suitability of an investment for their circumstances, they should seek advice.

No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment.

Past performance is not a guide to the future and investments rise and fall in value so investors could make a loss.

This factsheet has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

Information correct as at 19 June 2020 unless otherwise stated. This publication is issued by Hargreaves Lansdown Asset Management Ltd, One College Square South, Anchor Road, Bristol BS1 5HL who are authorised and regulated by the Financial Conduct Authority.

Benjamin Graham and the Intelligent Investor

Born in London in 1894, Graham taught at Columbia Business School during the Great Depression, counting one Warren Buffet among his students. He also ran his own investment partnership, reportedly achieving an average annual return of over 20%.

To understand how Graham thought about investing in individual companies you need to understand how he thought about the stock market.

Imagine owning a small stake in a private business. You have a significant business partner called Mr Market. Every day Mr Market gives you a price for what he thinks your stake is worth. Sometimes his estimates are sensible, but sometimes he “lets his enthusiasm or his fears run

away with him” and the price he quotes seems remarkably high or laughably low. This, Graham argues, is much the same position that small investors in stock market listed companies find themselves.

Viewing the stock market through the lens of Mr Market has some important consequences:

1. Market movements don’t mean anything in and of themselves

2. There is a difference between the price of shares and the value of shares

To some extent any investor who doesn’t simply own a tracker fund has to believe the above is true. Investors look to sell Mr Market expensive stocks when his prices are high, and buy cheap stocks when prices are low.

It follows that it’s possible to buy stocks on the stock market for less than they’re intrinsically worth.

However, when Graham’s talking about what stocks are intrinsically worth he’s not really talking about their future growth prospects. In fact he’s not that interested in the higher end of financial analysis at all. He argues that investors can, and should, buy stocks at a price below what they’re tangibly worth today, not what they might be worth in the future.

MARGIN OF SAFETY The “Central Concept of Investment” is, according to Graham, the margin of safety. And that’s all about minimising risk.

Graham argues that instead of looking at a share you think is slightly under-priced you look for something that’s hugely so. Those opportunities will be less common, but they’re also far less risky.

Take the example below:

If we’re correct about our estimation of the value of company A we might make a 4% return. Great. But there are so many ways in which we could be wrong about the value of A. Perhaps some key employees leave, or the economy goes into recession. If we’re out by as little as a few percentage points we could end up losing money. Even if we’re right in our estimation of company A’s valuation there’s no guarantee the market will ever recognise it.

Risking our initial investment for a relatively measly 4% return doesn’t seem too smart.

By comparison B looks like a much safer bet. We can be out on our estimation of the true value of stock B by 20% and still make a healthy 40%+ return. This is what Graham means by having a margin of safety. It’s a buffer against being wrong.

The above is a simplified example. As always it’s important to remember that all investments can fall as well as rise in value so you could get back less than you invest.

Stock A Stock B

Market Cap £50m £50m

Estimated Value £52m £90m

Graham’s investment criteria

Graham was a big believer in diversification. His is not a recipe for guaranteed success with every investment – such a recipe doesn’t exist. However, he believed that his approach would deliver positive results over the long run and a range of investments. He also believed that all investors needed a combination of bonds and stocks & shares in their portfolio.

Graham is probably best known for what he called “Bargain Issues” - although he suggested that only a certain type of investor consider these investments. These companies could be bought for less than their net-current asset value. They’re essentially companies whose market value is lower than the cash and inventory they have on hand.

These companies are what is sometimes known as ‘deep value’. They’re few and far between, are often very risky and usually unloved for a reason. But, if you invested in enough of this type of business Graham believed you would outperform over the long run.

Graham today

Today it’s perhaps easier to say what Graham definitely wouldn’t own than what he would.

Graham had a critical view of overvalued ‘growth’ stocks. Not because these companies can never deliver a good investment return, many do, but because if anything goes wrong the risk to the money you initially invested is substantial. He would probably be staying clear of the big tech stocks and the ‘steady eddie’ consumer goods companies.

But nor would he be rushing to buy every stock which has seen its share price battered by coronavirus and the oil crash.

For Graham the intelligent investor takes advantage of Mr Market only when he think there’s value to be had.

We’ve run his rules over the 350 largest companies listed on the London Stock Exchange to see which UK companies he might be interested in today. Eleven companies meet his minimum requirements for “enterprising investors”.

Any lessons you choose to consider from Graham’s approach will depend on your personal goals, circumstances and attitude to risk. As always, remember that all investments can fall as well as rise in value so you could get back less thanyou invest.

Now it’s worth bearing in mind that these were ‘minimum conditions’ necessary for Graham to even consider investing in a company. Given that a value approach often throws up some more troubled companies he would then go on to have a closer look to decide whether to invest. We’ve done exactly that for a few of these companies.

Keep up to date with the latest investment newsEvents are changing daily.

We’re keeping investors up to date with the latest investment news to help them make the most of their money

You can read all our insight at www.hl.co.uk/news or sign up to our weekly email updates.

11 UK COMPANIES THAT MEET GRAHAM’S REQUIREMENTS FOR “ENTERPRISING INVESTORS” *

Anglo American

Barratt Developments

Bellway

Countryside Properties

Crest Nicholson Holdings

Ferrexpo

Grafton Group

Pearson

Redrow

St Modwen Properties

Vesuvius

*Based on data from Refinitiv Datastream at 16/06/20

READ LATEST NEWS AND INSIGHT

SIGN UP FOR WEEKLY UPDATES

Barratt Developments

Barratt Developments is the UK’s largest housebuilder by sales – and one of several housebuilders in the list above. The sector was forced to shut down almost entirely in the early days of the coronavirus outbreak. And although construction is back underway, following social distancing rules means output is unlikely to be what it otherwise might have been.

Housebuilding is generally a cyclical business – in short this means it rises and falls along with the wider economy. When times are good, demand for new houses is high and so are prices. During a recession though house sales and prices can fall hard. With a severe recession looking likely, it’s perhaps unsurprising housebuilders make an appearance in a list of “value” stocks.

However, Graham’s approach is also designed to look for signs of financial strength. At the end of April Barratt Developments had £430m of cash available. The group has also taken steps to preserve cash by cutting the dividend, suspending land purchases and trimming management pay. Together with a further £700m in available debt funding that should provide the company with enough dry powder to weather the immediate storm.

In fact housebuilders fared much better than we had expected in the crisis so far. While sales have fallen – unsurprisingly given showrooms were shut – customer interest has continued, and rival builders have continued to sell properties at pre-crisis prices.

Longer term the sector continues to enjoy several tailwinds. That includes a nationwide housing shortage, a national obsession with home ownership and (for the time being at least) record low interest rates that keep mortgages comparatively affordable.

For all that we remain cautious about housebuilders in the medium term – and with Barratt Developments trading on a price to book value of only a little over 1 we’re clearly not alone. Nonetheless the combination of a strong balance sheet and long term growth drivers could prove profitable for those prepared to accept a rocky ride.

SEE THE LATEST BARRATT DEVELOPMENTS SHARE PRICE, CHARTS AND HOW TO TRADE

SIGN UP FOR BARRATT DEVELOPMENTS UPDATES

Pearson

On paper at least Pearson should be a winner from the current lockdowns. The group has spent years and millions of pounds shifting its textbook business online, and with schools and universities shut digital education materials should be in high demand.

However, despite all those efforts, physical and semi-physical operations still account for a large chunk of overall sales. Unsurprisingly the closure of Pearson’s test centres and lack of examinations in many countries this year have seen revenues fall.

There’s good news too though. The group’s managed to attract hundreds of thousands of new digital users in the UK and sales in Global Online Learning are up 6% in the first quarter. We suspect that, with disruption perhaps dragging into the next academic year, many schools and universities are seriously considering online teaching for the first time. That could have a lasting impact on demand for Pearson’s products, and existing relationships with schools will come in useful if changes are introduced at short notice.

However, a good deal of the new customers are taking advantage of Pearson’s offer to make certain resources available free of charge during the lockdowns. We’ve never been worried about the demand for high quality, online learning materials, but rather whether users would be prepared to pay for them. We’re not sure that question has been answered yet.

In order to fund the shift to digital Pearson has been selling off its most valuable print assets. Most recently that includes its remaining stake in Penguin Random House, for which it received £530m. We’ve not always been convinced by that policy, but it does mean the group’s balance sheet is in a relatively good place. Education can benefit from economic uncertainty too – since the unemployed return to education to skill-up.

It would be remiss not to mention the fact there’s serious change coming at the top for Pearson though. Long serving CEO John Fallon is due to step down shortly,

and the CFO has also been replaced within the last 6 months. However, with transition to digital well advanced and market opportunity clear it might not be a bad time for a clean slate.

Pearson has staked a lot on a digital future. That future is still uncertain, but after a messy few years the story is now a lot simpler.

SEE THE LATEST PEARSON SHARE PRICE, CHARTS AND HOW TO TRADE

SIGN UP FOR PEARSON UPDATES

Vesuvius

Vesuvius specialises in “metal flow engineering” – essentially designing and manufacturing components used in blast furnaces and metal casting.

Because of the extreme conditions under which its products operate they have a relatively limited life and so sales rise and fall with global steel manufacturing. Because steel is a key industrial input, and industrial demand turns on and off quickly in a downturn, Vesuvius is in many ways a classic cyclical stock.

Steel markets were already challenging, and coronavirus has inevitably made things worse. The group saw sales fall 28% in April.

While the outlook for global steel markets is out of its control, the current crisis hasn’t taken management totally by surprise. As a cyclical stock Vesuvius was already running a relatively conservative balance sheet. Net debt at the start of the year was around 1 times cash profits, with considerable breathing space over the limits imposed by lenders. The group has trimmed capital expenditure plans, cancelled its dividend and expects to save around £30m from other cost saving measures this year.

Vesuvius does have some long term attractions. Not only are its products complex and specialist, which means it can boast high barriers to entry, but it invests heavily in Research & Development (R&D) to make sure it remains cutting edge. In 2019 the group spent £29.1m on R&D, equivalent to 33.6% of profits, across 6 R&D centres around the world.

Unfortunately the challenge for investors where Vesuvius is concerned is gauging how long the current downturn is likely to last. That’s difficult, if not impossible, to judge and previous commodity downturns have led to significant share price falls. However, when the market does turn Vesuvius will hope to join the rally.

SEE THE LATEST VESUVIUS SHARE PRICE, CHARTS AND HOW TO TRADE

0620

BUY SHARES IN 3 SIMPLE STEPSReady to start buying shares?

The good news is that it’s much easier than you might think. If you don’t have a share dealing account, you could open one online today in minutes.

Then:

1. Log into your account

2. Select the share you want to buy

3. Get a live price and buy, or set a limit

Find out more about our share dealing service and charges

Issued by Hargreaves Lansdown Asset Management. www.hl.co.uk