by John Reese, editor Validea
Known as "The Father of Value Investing", Benjamin Graham inspired Mario
Gabelli, John Neff, John Templeton, and, most famously, Warren
Buffett. All were Graham disciples who went on to their own stock
market greatness.
Born in England in 1894, Graham built his
reputation -- and fortune -- by using an extremely conservative,
low-risk approach to investing.
Having lived through both his own family's financial troubles and the
1929 market crash, it's no surprise that the strategy Graham laid out in
his classic book
The Intelligent Investor was a conservative, loss-averse approach.
To
Graham, an investment wasn't something that could be turned into quick,
easy profits; anything that offers such "easy" rewards also comes with
substantial risk, and Graham abhorred risk.
In terms of
specifics, Graham's approach limited risk in a number of ways, and my
Graham-based model lays out several of those methods.
For
example, one key criterion is that a firm's current ratio -- that is,
the ratio of its current assets to its current liabilities -- is at
least two, showing that the firm is in good financial shape.
The approach also targets financially sound firms by requiring that long-term debt not exceed net current assets.
Two other criteria the Graham method uses to find low-risk plays: the price/earnings ratio and the price/book ratio.
Graham wanted P/E ratios to be no greater than 15 (and, as another
signal of his conservative style, he looked not only at trailing
12-month earnings but also at three-year average earnings, to ensure
that one-year anomalies didn't skew the P/E ratio).
For the
price/book ratio, he used a more unusual standard: He believed that the
P/E ratio multiplied by the P/B ratio should be no greater than 22.
My
Graham-inspired strategy tends to find bargains across a variety of
areas of the market. Here are the current holdings of the 10-stock
Graham portfolio:
Forest Laboratories (
FRX)
Curtiss-Wright (
CW)
Helmerich & Payne (
HP)
NTT DoCoMo (
DCM)
United Stationers (
USTR)
GameStop (
GME)
General Dynamics (
GD)
USANA Health Sciences (
USNA)
DeVry (
DV)
Walgreen (
WAG)
Since
I started tracking my Guru Strategies more than nine years ago, the
performance of my Graham-based model has been rather remarkable. Even
though the strategy Graham outlined is now more than 60 years old, it
just keeps on working.
Through July17, the 10-stock Graham-based
portfolio was up 179.2% since its July 2003 inception, making it my
second-best performer. That's a 12.1% annualized return in a period in
which the S&P 500 has gained just 3.5% per year.
The model's
strict balance sheet criteria helped it avoid big losers in 2008, as
the portfolio lost less than half of what the broader market lost, and
it rebounded big in 2009 and 2010, gaining 31.4% in '09 and 22.6% in
'10.
In 2011, it had its worst year, however, falling 19.0%
while the broader market was flat. It's rebounded nicely in 2012,
though, having risen 10.7% vs. 8.4% for the S&P, indicating that
last year was an aberration.
It's also worth noting that the
20-stock Graham-based portfolio I track has been even better. In fact,
it's the best performer of any of my 10- or 20-stock portfolios, having
returned 259.7% since its July 2003 inception -- that's 15.3% per year.
The
Graham portfolios' long-term results are a great demonstration of how
successful stock investing doesn't need to be incredibly complex or
cutting-edge.
You don't need fancy theories or gimmicks; you
just need to focus on good companies whose stocks are selling at good
values. Do that, and you should produce some strong results of your own.