In the introduction to the 2005 Harper Collins revised edition of The Intelligent Investor Jason Zweig, a columnist for The Wall Street Journal, described author Benjamin Graham as “the greatest practical investment thinker of all time.”

Mr. Zweig summarized Mr. Graham’s core investing principles as follows:

• A stock is not just a ticker symbol or an electronic blip; it is an ownership interest in an actual business, with an underlying value that does not depend on its share price.
• The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.
• The future value of every investment is a function of its present price. The higher the price you pay, the lower your return will be.
• No matter how careful you are, the one risk no investor can ever eliminate is the risk of being wrong. Only by insisting on what Graham called the “margin of safety”–never overpaying, no matter how exciting an investment seems to be–can you minimize your odds of error.
• The secret to your financial success is inside yourself. If you become a critical thinker who takes no Wall Street “fact” on faith, and you invest with patient confidence, you can take steady advantage of even the worst bear markets. By developing your discipline and courage, you can refuse to let other people’s mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.

At the end of the day, the most important element of a sound investment decision, acknowledged by Mr. Graham, too, is a quality underlying business. It follows from this first principle that you must protect yourself against losses and that you should aim for “adequate” rather than spectacular returns.

Benjamin Graham is also the author of the equally essential Security Analysis, which represents the coming of age of the young graduate who started out of Columbia University–turning down offers to lecture in three departments, English, philosophy and mathematics, at his alma mater–at the Wall Street firm Newburger, Henderson & Loeb and quickly became a one-man statistical department.

Mr. Graham suggested that reasonably priced stocks could be identified by multiplying the price-to-earnings (P/E) ratio by the price-to-book (P/B) ratio. If the resulting number was below 22.5 the stock represented reasonable value. We’ve calculated this number for eight stocks in the table “High Yield, Good Value, Low Volatility” and labeled it the “Graham Factor.”

As with most ratios, the average P/B value may vary from industry to industry. But it does provide some idea as to whether you’re paying too much for what would be left if the company went bankrupt immediately. The rule of thumb Mr. Graham applied was “1.5.”

As for the P/E ratio, anything above 15 is too much. The “Graham Value” bright line is thus 22.5, or 1.5 times 15.

Prices listed are US dollar conversions of closing prices as of Jul. 11, 2012, on the Australian Securities Exchange (ASX). The yields for all eight stocks exceed the average yield of the S&P/ASX 200 Index, which as of Jul. 11 was 5.1 percent.

We’ve included, in addition to price, yield, P/B and P/E ratios and the Graham Factor, two other pieces of information in the table “High Yield, Good Value, Low Volatility.” “Beta” is a measure of relative volatility that indicates the price variance of an investment compared to the market as a whole. “Safety Rating” is each company’s score according to the Australian Edge Safety Rating System.

“Beta,” explained Mr. Graham, “is a more or less useful measure of past price fluctuations of common stocks. What bothers me is that authorities now equate the beta idea with the concept of risk. Price variability yes; risk no.

“Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earnings power through economic changes or deterioration in management.”

For risk, we have the AE Safety Rating System, which is based on six criteria:

• We award a Safety Rating point to companies whose businesses are generally shielded from the ups and downs of oil and other resources.
• We award a point to companies for not cutting their dividends at any time in the past five years, a period which encompassed the Great Financial Crisis and provided stern tests for operating businesses of all stripes.
• We award a point to companies that have increased their dividends during the preceding 12 months, as dividend growth is the surest sign of a safe payout.
• We award a point to companies with low debt-to-assets ratios, which measures total obligations against the assets that would make good on them during a bankruptcy. This criterion is based on a sliding scale; businesses that have steadier revenues, such as pipelines, can sustain higher levels of debt than others, such as energy producers.
• We award a point to companies with low two-year debt-to-market capitalization ratios, which measures the debt companies would have to come to market to refinance were a real credit event to strike between now and the end of 2013. Debt is only significant relative to the size of the enterprise doing the borrowing, i.e. a USD100 million bond rollover is critical to a USD100 million company but insignificant to a USD100 billion one. We’re also more likely to give a break to a company in a stable business.
• And we award a point to companies with low payout ratios, which are calculated by dividing the indicated annualized distribution rate by the last 12 months’ relevant measure of profits.
• That’s usually earnings per share, after taking out any one-time gains or losses. Some companies, however, pay dividends from cash flow, so this is one indicator we always tally individually when analyzing companies. This criterion too is based on a sliding scale sensitive to the type of industry in which the company operates.

The more criteria a company meets, the higher is its AE Safety Rating and the more secure we can infer its dividend to be.

Explaining Anomalies

The eight stocks included in the table “High Yield, Good Value, Low Volatility” represent selections from the How They Rate coverage universe that measure up based on their current yields besting the average for the S&P/ASX 200 Index; consideration of their Graham Factors; low volatility relative to the S&P/ASX 200 Index, the beta of which is 1.00; and an AE Safety Rating exceeding “3,” meaning the stocks all meet at least three of the criteria detailed above.

You’ll note the inclusion of four stocks whose Graham Factors exceed the master’s 22.5 bright-line mark, three by considerable margins. We have exercised some discretion, informed by factors such as extremely attractive current yield coupled with low volatility and a solid Safety Rating, including the particular facts relevant to each criterion.

Two of these companies, Codan Ltd (ASX: CDA), which has a Graham Factor of 46.67, and SMS Management & Technology Ltd (ASX: SMX, OTC: SMSUF, ADR: SMSUY), which scores 36.61, operate in the technology sector, where higher valuations are the norm. The Technology group in the AE How They Rate coverage universe sports average P/E and P/B ratios of 15.27 and 3.68, respectively, and an average Graham Factor of 58.90.

Codan has a beta of 0.60, SMS 0.75. The average for the Technology group is 0.64. Both earn “5s” under the Safety Rating System.

As for events on the ground, in mid-April Codan boosted its underlying net profit after tax (NPAT) guidance to “in the region of” AUD26 million for the full financial year. Management now expects underlying NPAT to exceed fiscal 2012 first-half levels. Previous full-year guidance was for underlying NPAT “in the region of” AUD20 million.

The upgrade was largely driven by increased sales of gold detectors in Codan’s African markets, and this is the result of a concerted effort to promote the use of these products in new parts of the Dark Continent. These efforts, combined with a focus on making it easier for customers to more easily purchase verifiably solid Codan detectors has paid off.

Codan’s core radio communications business continues to expand its product offering and customer base. Management expects the unit to show “significant” profit growth for the full fiscal year.

The recently acquired Minetec business posted solid results during its initial quarter under Codan and remains on track to deliver the forecast AUD1 million earnings before interest, taxation, depreciation and amortization (EBITDA) for fiscal 2012. Minetec should provide significant growth going forward as its integration into Codan’s larger operation continues.

Codan hasn’t cut its dividend during the past five years and in fact has consistently made modest increases to its payout. The last increase was more than a year ago, though, which is the only thing keeping it from a perfect “6” score under the AE Safety Rating System. The payout ratio is modest 67.8 percent, and the overall debt burden is light, with no significant maturities in the short term. Codan, which yields 6.2 percent at current prices, is a buy under USD1.50.

SMS is a little company in the global IT scheme, but it can and does dominate the Australian management consulting/software services space. SMS has managed to establish what amounts to a subscription/fee-based business that relies on contractual relationships with major Australian companies.

Eighty-five percent of the top 20 companies on the Australian Securities Exchange use SMS services. Its international expansion model is based on “following Australian clients into Asia.”

It’s done this through major contracts with Telstra Corp Ltd’s (ASX: TLS, OTC: TTRAF, ADR: TLSYY) international division in Hong Kong; by helping Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY) execute on its “super-regional” strategy; and via work with BHP Billiton Ltd’s (ASX: BHP, NYSE: BHP) MinEx division in Singapore.

It boasts an impressive share of cash flow is “repeatable,” meaning it’s locked in under long-term contract. The company’s main areas of operation are with clients for whom IT–information technology–is core to their business and for whom investment in processes and systems is part and parcel of staying in business. For folks like the Big Four banks–three of whom are SMS clients–it’s more and more critical part of saving money and operating efficiently.

For the first half of fiscal 2012 it posted 16.1 percent sales growth, while management’s fiscal third-quarter “assessment” revealed “strong” demand from information and communications technology (ICT) clients, utilities, transports, health care and resources but “soft” demand from financial services firms. SMS has booked AUD301 million in new contracts, well ahead of the AUD265 million at a comparable point of calendar 2011.

SMS has proven its ability to manage what can be volatile earnings cycles for IT/consulting companies. Recurring revenue continues to grow, and management is steadily working its way up to larger contracts. The company also has solid and sustaining federal government contracts.

The balance sheet is strong, with zero debt and cash of AUD24.88 million on hand. SMS policy is to distribute to shareholders via dividends 65 percent to 70 percent of NPAT. SMS declared its first regular dividend in February 2005 and has never cut.

SMS Management & Technology–which is yielding nearly 5.8 percent at current levels–is a buy up to AUD6 for a reliable and rising dividend and impressive capital-gains potential.

GUD Holdings Ltd (ASX: GUD, OTC: GUDHF, ADR: GUDDY), on the other hand, is well above the average Graham Factor for its fellow Consumer Goods companies in How They Rate, 37.54 versus 13.69. The P/E ratio is within reasonable range of Mr. Graham’s 15 threshold mark, though GUD’s P/B is 2.43. It is less volatile than the broader market, however, and it earns a “4” Safety Rating, including one point for boosting its dividend during the last 12 months.

During the first six months of fiscal 2012 GUD’s revenue grew by 4 percent to AUD311 million. This period included a full contribution from the Dexion business, which was acquired in mid-2011. Dexion makes pallet racking, shelving and integrated systems for use in warehousing and storage as well as cabinets, shelving, lockers and mobile units used for storage in the commercial office sector.

Through its several brands, including Dexion and Sunbeam, GUD manufactures, imports and distributes cleaning products, household appliances, automotive products, locking devices, pumps, pool and spa systems, and water pressure systems.

Its Consumer Products segment includes small electrical appliances and cleaning products; Automotive Products includes automotive and heavy duty filters for cars, trucks, agricultural and mining equipment, fuel pumps and associated products.

Water Products includes pumps and pressure systems for household and farm water, swimming pool products, spa bath controllers and pumps and water purification equipment. Industrial Products manufactures industrial storage and automation solutions plus disc tumbler locks for furniture, doors and safe locking systems.

Statutory NPAT, including AUD800,000 in restructuring and acquisition costs, declined 1 percent to AUD23 million. Underlying NPAT slid 13 percent to AUD23.8 million because of “soft” trading conditions. Reported earnings per share were off 4 percent to AUD0.331.

At the same time, however, GUD boosted its interim dividend 3 percent to AUD0.30 per share.

Management forecast full-year earnings before interest and taxation (EBIT) to be “slightly ahead” of fiscal 2011 levels, with a stronger second half from Dexion offsetting weakness in Consumer Products and Water Products.

The most compelling factor in the GUD story is that its dividend history is remarkably consistent given the condition of the global economy during the past half-decade. In 2009 management did reduce the interim dividend from AUD0.30 to AUD0.27 and the final dividend from AUD0.38 to AUD0.33. But it began boosting from these levels in 2010, to AUD0.28 and AUD0.34, and again in 2011, to AUD0.29 and AUD0.35. Over 10 years the interim dividend has grown from an initial AUD0.075 to the recently raised AUD0.30. Management will make its next dividend announcement on or about Jul. 26, when it reveals fiscal 2012 full results.

GUD Holdings, yielding 7.6 percent, is a buy on dips to USD8.25.

As for UGL Ltd (ASX: UGL, OTC: UGLLY), its Graham Factor is well below the average of 39.61 for How They Rate Industrials, and it scores a solid “5” on the AE Safety Rating System, including points for not cutting its dividend during the past five years and for boosting it in the last 12 months. It is slightly more volatile than the S&P/ASX 200 Index as well as its How They Rate group, but this reflects a rapid recovery off the 12-month low of AUD6.90 it established, coincidentally, the day Australian Edge launched, Sept. 26, 2011.

Sydney-based UGL provides outsourced engineering and property management services and asset management and maintenance. It comprises three business units, including Engineering; Operations & Maintenance; and Property. It works across the power, water, rail, resources, property, transport, communications and defense sectors. UGL employs approximately 55,000 people in 45 countries.

Its Property unit secured approximately AUD350 million in new contracts during the three months ended Jun. 30, 2012, Naval Ship Management Ltd, a 50-50 joint venture between UGL and Babcock Ltd, finalized a new five-year, AUD300 million win for the ANZAC Ship Group Maintenance Contract (GMC) with the Defence Materiel Organisation. The UGL-Babcock JV will provide ship repair and maintenance services for the eight Royal Australian Navy ANZAC frigates.

Management reported underlying NPAT of AUD72.2 million for the first half of fiscal 2012, up 6 percent over the prior corresponding period, on operating revenue of AUD2.4 billion, which was up 5 percent. UGL secured more than AUD3.4 billion in new contracts and extensions during the period, and this trend carried into the second half of the year. UGL’s order book is now at a record AUD9.5 billion, with more than 63 percent made up of maintenance-style contracts.

Management’s forecast is for full-year fiscal 2012 underlying NPAT growth of “around 5 percent” above fiscal 2011 levels. This excludes the impact of the DTZ acquisition, which is forecast to be “marginally” accretive to earnings per share. CEO Richard Leupen has said he believes UGL can return to 10 percent to 15 percent normalized NPAT growth in the short
term.

Look for UGL to declare a final dividend of AUD0.39 per share, up from AUD0.38 in the prior corresponding period. UGL, which is currently yielding 5.8 percent, is a buy under USD14.

Bargain Bin

GWA Group Ltd (ASX: GWA, OTC: GWAXF, ADR: GWAXY) is Australia’s leading supplier of building fixtures and fittings to households and commercial premises. It owns such brands as Caroma, Dorf, Fowler, Stylus, Clark, Radiant, Irwell, Dux, Brivis, Gainsborough, Austral Lock and Gliderol and is the exclusive Australian distributor of Hansa and KWC.

GWA is on the AE Dividend Watch List because it recently reduced guidance shortly after reporting fiscal 2012 first-half results.

Right now it looks like a classic value play, with both its P/E and P/B ratios below Mr. Graham’s critical thresholds. The company has a low overall debt burden relative to total assets, and it has no maturities until 2014. Critically for us, GWA hasn’t cut its dividend during the past five years.

The company reported an 11 percent sales decline for the six months ended Dec. 31, 2011, as revenue dipped 1 percent to AUD314.9 million. At the time these numbers were released, on Feb. 14, management forecast a 16 percent decline in earnings before interest and taxation (EBIT). On Apr. 10, however, via a trading update, GWA altered its EBIT decline for fiscal 2012 to 20 percent to 25 percent.

But management once again confirmed its full-year dividend guidance of AUD0.18 per share.

GWA is refocusing around its core Building Fixtures and Fittings businesses. During the first half of fiscal 2012 the company made significant progress with its restructuring initiatives, as the overall workforce was reduced by 7 percent from October through Dec. 31, 2011, a faster pace than management targeted. Staff reductions were made in GWA’s Bathrooms & Kitchens division and in the Gainsborough business, which manufactures door security products and locks. Management forecast a further 2 percent reduction by the end of the fiscal year (Jun. 30, 2012).

GWA Group, which is currently yielding 8.9 percent, is a buy under USD2.

Sydney-based Amalgamated Holdings Ltd (ASX: AHD, OTC: AMGHF) has managed to complement its 1,000-plus movie screen theater interests in Australia, New Zealand and Germany with hotel operations, a consistent mix that establishes it as a global leisure services provider.

Its latest venture is a niche hotel operation in Australia, QT, that caters to sophisticated travelers and those interested in a unique food and drink experience.

The company’s Graham Factor reflects P/E and P/B ratios below the critical 15 and 1.50 levels, respectively, while its 0.45 beta suggests a stock that you can rest easy with.

Amalgamated earns two points under the AE Safety Rating System because of a low overall debt burden relative to total assets and minimal maturities coming due before the end of 2013. The company has never cut its dividend, and its fortunes aren’t tied to commodities prices. No regular dividend increases during the past 12 months and a payout ratio a little outside the comfort zone stand between it and a perfect “6” rating. The company does regularly top off payouts to shareholders with special dividends.

For the first half of fiscal 2012 Amalgamated reported normalized profit (profit before interest, discontinued operations, one-time items and tax) of AUD65.6 million, up 7.7 percent over the prior corresponding period. Strong results from the company’s German cinema operations circuit and was largely offset by a very poor 2011 Australian ski season and its impact on the Thredbo resort.

Hotels & Resorts generally performed well, with strong growth in average room rates, but were impacted by major guest room refurbishment projects at Rydges Lakeside Canberra and the new QT Gold Coast project.

In Cinema Exhibition, Australian theaters experienced a marginal decline in box office, but solid growth in merchandising revenue and a reduction in operating costs produced year-over-year earnings growth of 6 percent. New Zealand movie theaters posted growth of 9.6 percent.

During its annual general meeting in mid-October management, because of the uncertainty surrounding many of the world’s economies, declined to offer specific guidance for the remainder of fiscal 2012. Managing Director David Seargeant did note that Amalgamated is “well positioned to continue to meet challenges.” During the three years that have come to mark the global financial crisis Amalgamated was able to expand market share, completing acquisitions totaling AUD211 million.

For fiscal 2011 the board declared a final dividend of AUD0.23 per share as well as a special dividend of AUD0.04 per share. The total annualized dividend of AUD0.41 per share was up 11 percent over fiscal 2010, the 10th straight year of dividend growth. Again, though, this growth is driven by special dividends, not regular interim or final dividend increases.

Cash and cash-like instruments were AUD115.6 million at the end of fiscal 2011, while the company had total debt outstanding of AUD47.4 million. Amalgamated has approximately AUD270 million of credit facilities maturing Jul. 10, 2012, on which, as of Jun. 30, 2011, AUD46.3 million was drawn. Management has begun negotiations for new credit facilities.

A solid player in an industry capable of generating significant cash flow, Amalgamated Holdings is a buy under USD6.50.

Ridley Corp (ASX: RIC, OTC: RIDYF), the biggest animal feed and salt producer in Australia, is another that looks compelling according to the Graham Factor. Its low beta and solid AE Safety Rating (the company hasn’t cut its payout in the last five years, it has a low debt-to-assets ratio and no significant maturities before the end of 2013 and has little direct exposure to commodities prices) also speak well of the stock.

Ridley got started in 1987 as a stock feed manufacturer. In 1990 it purchased Barastoc Stockfeeds, and these operations now comprise Ridley AgriProducts (RAP). RAP is Australia’s largest commercial provider of stock feed and animal nutrition supplements. It holds an approximate 25 percent share of the available market, that is the approximately 50 percent of total stock feed demand that isn’t vertically integrated into large farming operations.

RAP sits neatly between grain handlers and livestock producers, adding value in the livestock/protein industries with a focus on poultry, pigs and dairy.

Ridley acquired Cheetham Salt, the largest producer and refiner of salt for sale into the Australian market, in 1992. Cheetham’s salt is sold to several industries, including water treatment, stock feed, food manufacturing, chemicals and the pool sector. In 2011 Ridley acquired primary chicken and fish specialist protein meal supplier Camelleri Stockfeeds for AUD35 million.

Fiscal 2012 first-half net profit after tax (NPAT) was AUD11.9 million, down 25.5 percent from AUD15.9 million during the first half of fiscal 2010, on the return to a normal tax rate of 26 percent following a one-off adjustment the prior period. Revenue from continuing operations grew 1.3 percent to AUD378.3 million from AUD373.6 million.

Operational EBITDA (earnings before interest, taxation, depreciation and amortization) was AUD20.9 million, up slightly from AUD20.6 million in the prior corresponding period. Ridley AgriProducts generated EBIT for the half year of AUD14.9 million, up from AUD12.8 million. Cheetham generated EBIT of AUD6.5 million, down from AUD7.8 million because of higher salt production and supply chain costs.

In December 2010 Ridley finalized a new AUD169 million bank debt facility to replace a AUD150 million cash advance due for repayment in December 2011. The new facility includes term debt available to be drawn down in tranches, with terms of between two and four years. “Gearing,” or net debt, rose to 41.2 percent as of Dec. 31, 2011, because of the Camilleri acquisition.

Ridley’s board declared a total cash dividend in respect of fiscal 2011 of AUD0.075 per share. For the first half of 2012 it paid AUD0.0375, flat with the year-ago rate. Ridley, yielding 7.3 percent, is a buy under USD1.30.

Tabcorp Holdings Ltd (ASX: TAH, OTC: TABCF) is an Australian wagering, gaming and Keno operator with a media unit attached to it. It’s one of the biggest publicly trading companies in the world. Based in Melbourne, Tabcorp was formed in 1994 from the privatization of the Victorian Totalizator Agency Board (TAB).

It has the lowest Graham Factor of the stocks we’re profiling, and it also sports the highest yield. It is for aggressive investors with money to gamble with.

The stock has been in a long downtrend, falling from an May 4, 2007, all-time closing high of AUD8.08 on the Australian Securities Exchange (ASX) to an all-time closing low of AUD2.48 on Oct. 4, 2011.

The downside has been particularly steep since April 2008, when the government of the Australian state of Victoria changed the way it awarded gaming licenses, shifting from an effective duopoly where Tabcorp and competitor Tatts Group Ltd (ASX: TTS, OTC: TTSLF) held exclusive rights to own operate poker machines to a system based on awarding licenses to venues.

The event Australians refer to as the “Great Financial Crisis” impacted gaming and wagering activity Down Under, and the company’s announcement of a structural separation created additional uncertainty. Always looming is the threat of government in what is a highly regulated segment of the Australian economy.

But after splitting casino and hotel operations from the core gaming, wagering and keno operations Tabcorp has posted solid if unspectacular results. Management has down-shifted its target dividend payout ratio from 70 percent to 80 percent to 50 percent to 60 percent of normalized net profit after tax, but at the same time it’s been able to focus on growing its businesses through investment and to maintain a decent balance sheet.

At these levels–it closed at AUD3.02 per share in Jul. 12 trading on the ASX–Tabcorp is priced to yield 10.6 percent. The dividend rate does vary based on operating results and is not fixed in the manner of North American dividend-paying companies.

But revenue continues to grow and underlying earnings are healthy, even in this difficult environment. And management recently refinanced the company’s fiscal 2013 maturing debt. Tabcorp has also secured important long-term licenses over the past year, removing some of the ever-present uncertainty that comes with this territory.

Buy Tabcorp, which is yielding 10.8 percent, under USD3.15.

It must be noted in closing that, as Mr. Graham notes in the first chapter of The Intelligent Investor, “Buying a neglected and therefore undervalued issue for profit generally proves a protracted and patience-trying experience.”