Added Levels of Safety

Earlier I have created my easy framework and simple criteria for deciding the purchase of a company. I have chosen these 3 simple metrics for selecting my stocks after reading Benjamin Graham's 800 page classic, Security Analysis. Basically these 3 metrics determine if a company's shares are overpriced or underpriced by in market; thereby determining its value.

The criteria are as follows:

1) Book Value - Net worth per share relative to latest market price per share

2) Price to earnings ratio - popular and simplistic indication of market price relative to earning power

3) Dividend yield - the percentage of actual share of profits you are getting on that specific market price

These are actually financial ratios. And the minimum ratings that I set for each one are as follows:

1) Book Value per share - =<1 (P/BV less than or equal to 1)

2) Price to earnings ratio - <10 (P/E less than 10)

3) Dividend yield - anything, prefer 2-4% and above, pegged to inflation rate

A stock selling at less than 1 price to book value means, the company's stock is selling less than the total of its net worth or equity or assets less liabilities. That's the price for the tangible assets and equipment of the company. The price to earnings ratio of less than 10 means you're getting at least 10% net income of the company per annum at that price. The lower the better. A P/E of 5 means you're getting around 20% of the company's net earnings at that price. Dividend yield is actually the part of the earnings or net income you get as cash. The higher the net profit and the lower the price, the higher the dividend yield. I generally want to peg the dividend yield to the current inflation rate so at least you get at least some of your money back even though the securities are already theoretically a hedge against inflation.

And while reading Robert Kiyosaki's book, The REAL Book of Real Estate, I came upon a table that shows some common metrics and financial ratios used for real estate properties, but properties also being little business units in themselves, I believe such ratios may also be used in gauging stocks.

The table reproduced below:

I have also read about debt coverage and current ratio in Value Investor, Benjamin Graham's book Security Analysis. These two, especially current ratio are very simple to compute, and are easily available just by looking at the latest financial statemets.

The current ratio shows the ability to pay liabilities and obligations. The debt coverage specifically covers the company's capacity to pay its indebtedness.

These two additional ratios may be used as a general gauge of SAFETY when selecting and screening stocks to invest in.