How Benjamin Graham would invest on the ASX

In this episode, Forager's Steve Johnson and Tyndall's Jason Kim channel the father of value investing, Benjamin Graham.
Buy Hold Sell

Livewire Markets

There are many famous fathers.

Hippocrates is the father of modern medicine, James Brown is the father of Soul, and Darth Vader is the father of Luke Skywalker.

But there is only one father of value investing, and that's none other than Benjamin Graham.

Graham, along with the oft-overlooked David Dodd, wrote the classic book on investing: The Intelligent Investor. It’s a staple for anyone who is serious about investing in general, and value investing in particular.

The central idea of the book is to approach investing with a long-term focus and to view stocks as ownership in a business, rather than mere pieces of paper to be traded.

The text also thoroughly covers the importance of in-depth analysis, risk management, and one of the most enduring principles – a margin of safety.

A margin of safety refers to buying a stock at a price below its intrinsic value, so as to provide protection against market gyrations.

So, how would the principles laid out The Intelligent Investor stack up today on the ASX?

To answer that question, Livewire's Ally Selby was joined by Forager Funds Management’s Steve Johnson and Tyndall Asset Management’s Jason Kim

Note: This episode was filmed on Wednesday 15 November 2023. You can watch the video, listen to the podcast or read an edited transcript below.

Edited Transcript

Ally Selby: Hello and welcome to Livewire's Buy Hold Sell. I'm Ally Selby, and today we'll be learning how the father of value investing, Benjamin Graham would invest on the ASX. To do that, we're joined by two local value investors. We've got Jason Kim from Tyndall Asset Management and Steve Johnson from Forager Funds Management. Okay, Jason, I'm going to start with you. What's your favourite Benjamin Graham quote or learning, and why do you think it's relevant to the market today?

Favourite Benjamin Graham quote or learning

Jason Kim: For me, it's got to be the parable of Mr. Market. This never ages. It's all about the emotions we see in the share market. The market can be quite fearful and it can be quite greedy, and we see it all the time. So the concept is that Mr. Market, when he feels very fearful, will knock on your door and offer to sell you shares at rock-bottom prices. And when he's very greedy and irrationally exuberant, he will offer to buy stocks from you at incredibly high prices. And as a disciplined, patient investor, we can take advantage of that and make good returns in the long run.

Ally Selby: Okay. Over to you, Steve. What's your favourite quote or learning from Benjamin Graham?

Steve Johnson: We've both picked things from The Intelligent Investor, which was Graham's second book, and it is more about the psychology of markets than the actual valuation of businesses. And I think his early stuff in security analysis, it's worth a read, but it's more applicable to the 1930s and '40s than it is to today. Whereas this stuff is really, it is timeless advice, and the big one for me is Chapter 20 of that book where he says the three most important words in investing are margin of safety. And it's understanding that the markets move in these cycles, understanding that a business has a value, but then demanding a really nice gap between what you think it is worth, using conservative assumptions, and where the market is trading at that point in time.

Would Graham invest in the ASX today?

Ally Selby: Benjamin Graham obviously didn't invest in Australian equities, but if he was alive today, do you think he would?

Steve Johnson: Probably not at today's valuations, and I think he would find the whole market difficult these days, because he liked to buy businesses at discounts to their liquid assets - so just take the cash and the amount of money it was going to receive and try and buy them for a discount to that. There are almost none of those businesses out there anymore, and the ones that probably deserve to trade where they trade. But we have a very value-heavy index here and I think he would be attracted to this market over some of the growthier-type markets, because there are more mining companies, banks, insurance businesses, the types of things that tend to trade at more attractive valuations relative, to say, the NASDAQ in the US.

Ally Selby: What do you think, Jason? Do you agree?

Jason Kim: I do largely agree, but also, like Steve, see a significant divergence in value within the Australian share market. So while we do have very expensive parts of the market in the tech and growthier names, trading at multiples way higher than what they should on average, we've still got a large part of the market that's incredibly cheap and trading at far lower multiples than they should be. And I think in today's environment, Ben Graham would be attracted to that part of the market. So we still see significant value in a section of the market today.

Where are you seeing the most value?

Ally Selby: When it comes to market cap, where are you seeing the most value? Is it smalls, mids, or larges?

Jason Kim: That's a great question. While there are pockets of value in all size buckets, given the relative underperformance of the small ords, I'd have to say there's probably more value to be had there.

Ally Selby: Okay. I'm guessing it's the same for you, Steve, given that's your area of expertise.

Steve Johnson: I would agree with that, Ally. And I think the further you go down, if you look at performance, it has got worse and worse and worse, the smaller market cap that you go to. But I think there is also value at the larger end of the market. Jason touched on this, but it's more about the type of business that people don't like at the moment than it is just about market cap, and I think there is some stuff at the larger end of the market that's pretty attractively priced too. That's true here in Australia and it's true overseas as well.

Name a stock Graham would buy

Ally Selby: As you mentioned earlier, Benjamin Graham preferred stocks that were trading below their intrinsic value, or their NTA. You also said there's not a lot of stocks like that in the world right now. I'm going to push you to find one. Is there an example of a stock on the ASX that you think Benjamin Graham would like?

Steve Johnson: They would not meet his very strict criteria about liquefiable assets, but the mining services companies are trading at discounts to the replacement cost of their assets, which is mostly mining equipment. I actually think if you went out and bought that equipment today, the price is 30% higher than what they paid for it. And you're buying McMahon (ASX: MAH), for example, at a price that is 50% of the value of those tangible assets. These companies are actually making profits, they're generating lots of cashflow. They are committed to returning that cashflow to shareholders. They're not horrible businesses and I think the outlook for the industry is reasonably positive. So they are, I think, examples of stocks that he would be drawn to.

Ally Selby: How about you, Jason? Do you have an example you could highlight there?

Jason Kim: Yeah, we sure do. We believe Stockland (ASX: SGP) is very attractive. It's trading at 0.9 times NTA. So if we look at its valuation of the property that it actually holds, it's roughly around $4.25 per share. It's trading at roughly $3.90. So, just on the assets it owns, it's trading at a discount to that. Now, some may argue, “Well, aren't property values likely to go down?” We would argue that in the case of Stockland, the vast majority of its assets, the valuation looks roughly right, being in regional shopping centres and in logistics or industrial-type assets. So it'll look okay to us. But what the market misses is that it's also a significant developer, and we believe that the development arm is worth roughly a dollar per share. So let's call it $5.20 plus per share, for $3.90. Going back to what Steve was saying, margin of safety, it's there. So we believe Stockland fulfils that criteria.

Which stocks have been overly punished?

Ally Selby: He was also a big fan of exploiting market volatility, which we've seen a lot of this year. Is there a stock that you think has been dragged by the press or has seen a lot of headwinds that you think Benjamin Graham would be buying?

Jason Kim: Certainly when we look at intrinsic value, he has spoken about looking at realisable growth in the near term and looking for risk price opportunities. So if you look at a stock like ResMed (ASX: RMD), for example, while it may be perceived to be a growth stock, it's not priced accordingly. It's trading at roughly 20 times earnings. It has defensive attributes and growth attributes. And we look at its performance over the last three or so months, it has fallen by way over a third, and that comes down to negative publicity and press. And what this is all about is the rise of the GLP-1 drugs. Think Ozempic, Saxenda. ResMed's business is all about providing CPAP therapy, of which a meaningful proportion are obese. This potential reduction in obesity through these GLP-1 drugs is a potential headwind for ResMed. But at roughly 20 times earnings, we believe it's massively overdone. And if anything, it may be a complimentary therapy. So we believe that it provides a significant opportunity.

Ally Selby: Okay. Over to you, Steve. Is there a stock where you feel like there's a lot of negative sentiment right now that you would be buying at this valuation?

Steve Johnson: We own ResMed too, so I could have picked that one and brought it today. But I, similar to Jason, am attracted to the property sector at the moment, where there is a lot of pessimism. I'm probably a bit more pessimistic about the actual valuations of these assets. I think the accountants who think they can use a 4.5% discount rate to value some of these properties when 10-year government bond rates are closer to five, are living in cuckoo land. And that's why we're not seeing any transactions out there. Nobody's trading because the buyers recognise that the prices are not worth what the sellers think they're worth.

So, I do think there's a bit of a reckoning to come there in terms of values coming down, but Charter Hall's (ASX: CHC) actually mostly a manager of property assets. It generates its fees from managing those assets, and you can afford for that revenue and profitability to come back a long way and still own a pretty attractively priced business. It jumped up quite a lot on the day that we are recording this. I think price is super important, so you need to be careful there around what price you pay. But that's one where the sector faces a lot of pessimism, and I think that it's actually a pretty good business underneath the surface.

Ally Selby: Nothing like backing a fund manager, hey?

Steve Johnson: It's a tough business.

It’s too crowded in here

Ally Selby: Okay, last question for today. What's a crowded or much-loved stock by the market that you think Benjamin Graham would be avoiding?

Steve Johnson: Well, he would avoid 99% of the market. And I think that's a really important lesson out of what he did, is that you can afford to be really selective in this business. And just because I wouldn't buy something doesn't mean it's a bad investment. It's really important to stay in your lane, and I think that's what he did really well and taught really well. So this is not necessarily a criticism, and I actually found this question a little bit harder than I would have six months ago, because some of the stuff that was a really crowded trade, like healthcare for example, you've had ResMed (ASX: RMD) and CSL (ASX: CSL) come back a long way. You've got Healius (ASX: HLS) trading at 52-week lows, the lowest prices it's been at in years.

So some of those crowded trades have unwound, and I think it's a bit more even than it was. I still think the quality tech stuff is pretty crowded and pretty expensive - the Xeros (ASX: XRO) of the world, WiseTechs (ASX: WTC). I love Xero as a business. I think it's fantastic. I just think you're paying a pretty full price in a world where you can generate double-digit returns from some pretty safe businesses quite easily.

Ally Selby: Okay, over to you, Jason. What's your crowded trade that you would be avoiding today, and why?

Jason Kim: Like Steve, I have to agree that the tech sector is very crowded. So we've seen the tech stocks rally very strongly over the last several years as interest rates have declined. In the course of 2022, they've corrected meaningfully, but they got their second wind late last year with the rise of ChatGPT once it got launched. And that AI thematic is very, very strong. And back to the comments that Steve made. Some companies may be great, but they can be terrible stocks. You can get a great company and a terrible stock, it's all about the price that you pay. And if there's one stock that looks very interesting but is priced terribly, it's got to be NextDC (ASX: NXT).

So, a very interesting company. Probably one of the only ways you can play the AI thematic in the Australian share market, but it doesn't make a profit and won't for many years to come. It does have positive EBITDA. 35 times EBITDA in anyone's language is very, very high. It's all about the market factoring the growth in these data centres to take advantage of AI. But they will need to invest continuously, and they'll need to raise equity, but at these levels, it doesn't make sense and there is no margin of safety.

Ally Selby: Okay. Well, that's all we have time for today. I hope you enjoyed that episode of Buy Hold Sell as much as I did. If you did, why not give it a like. Remember to subscribe to our YouTube channel. We're adding so much great content just like this every single week.

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