Ben Graham Approach to Investing Outperforms the Markets

I always find it interesting to look at the guru portfolios I run on Validea and ask the question “what is working now?" Over the last month, in a period where the S&P is up 0.4%, 11 out of Validea’s 13 portfolios have outperformed. The best performer is my Ben Graham strategy, up 9.4%. Incidentally, the Graham portfolio is also the best long term performer (up 89.3 percent vs. -12.9% for the S&P since July 15, 2003). The table below shows the performance of the 10-stock portfolios I run over the last 30 days.

In looking at the 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 long-term assets.

Two other criteria the Graham method uses to find low-risk plays are 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 used three-year average earnings rather than trailing 12-month earnings, to ensure that one-year anomalies didn’t skew the 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.

By using these conservative, fundamental-focused measures, Graham earned himself the moniker “The Father of Value Investing”. And as the father of that school of thought, he inspired a number of famous “sons” — Mario Gabelli, John Neff, John Templeton, and, most famously, Buffett, are all Graham disciples who went on to their own stock market greatness.

Perhaps the most intriguing part of Graham’s strategy is that, while it was published almost 60 years ago, it still works today. Since I started tracking it more than five years ago, my 10-stock Graham-based portfolio has racked up an impressive gain while the overall market is down.

Here are the current holdings of the 10-stock Graham portfolio:

Disclosure: At the time of publication, John Reese and clients of Validea Capital Management were long all of the stocks mentioned in this article.

Comments

[drone:]

Some of these stocks are on Greenblatt's Magic Formula List. I wonder how his strategy would compare on your performance test.

Jan 15 10:31 AM

[John Reese:]

We will be soon releasing Greenblatt's Magic Formula on Validea. We have been tracking the 10 & 20 stock Magic Formula since 2005. Once we go live with the strategy, I will post the performance, current holdings and more on Seeking Alpha.

Jan 15 11:31 AM

[Larry House:]

Ben Graham and many of his disciples, such as Buffett, also make it clear that there are times when one should be out of the market--wait for the "fat pitch" that can't be missed. One can identify all the value stocks one wants, but if the trend iof the market s down, the value stocks will go down too. If one has a holding period of say 30 years, today's value stocks look pretty good. I don't think they look so good over the next five years.

Jan 15 12:10 PM

[Glen Bradford:]

The Magic Formula and Graham have a lot more in common than you'd think. www.gurufocus.com/news...

I like the article. I respect that you are investing in this strategy. Adding you to my reading list.

Jan 15 02:18 PM

[John Reese:]

I appreciate the comments and thoughts guys. All very good points.

I am just getting started on Seeking Alpha, but you can find me on Forbes.com, RealMoney.com and at through my research site, Validea.com. I hope to post one interesting article per week and let’s see if I can get some good, valuable ideas out on the table.

Jan 16 07:19 AM