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In January 2012 I announced a new portfolio, a Benjamin Graham "inspired" value stock portfolio. The purpose of the hypothetical portfolio is to track returns for a portfolio of 15 stocks selected based on a variety of valuation metrics.

I originally intended to update the portfolio monthly; however, in the spirit of creating a lower turnover, value-driven portfolio it is now updated approximately once per quarter. I have also added an additional criteria to limit turnover in the portfolio (see below). The Graham portfolio is an attempt to add a value strategy to my site, which is otherwise focused on momentum, trend, income and market timing strategies.

The criteria used to select the stocks are listed below. The tool used to perform the screen and backtests are courtesy of Portfolio123 ("P123″).

The actual screen factors are below:

  • Liquidity filter: No OTC Stocks
  • Market capitalization > $100 million
  • Eliminate companies classified in the Miscellaneous Financial Services Industry, most of which are investment companies and funds and not the kind of stocks this all-star tended to seek
  • Current ratio must be at least 1.5
  • Long-term debt must be no higher than 10% above working capital
  • EPS must be above breakeven in each of the last four quarters and in each of the last five annual periods
  • Trailing 12 month EPS most be above EPS in the latest annual period
  • EPS in the latest annual period must be above EPS in the prior year and five years ago
  • The company must have paid common dividends in the last 12 months

The ranking system used as a basis for selecting the top 15 based among those stocks that pass the Graham screen are below:

  • Valuation – 60% of total
  • Trailing 12 month P/E (15% of this category)
  • Price-to-Book (15% of this category)
  • Price-to-Tangible Book Value (35% of this category)
  • Operating P/E, defined as Market Capitalization divided by Business Income, which is Sales minus Cost of Goods sold minus Selling, General & Administrative Expense and omits unusual items (35% of this category)
  • Earnings – 40% of total
  • 5-year EPS Growth Rate (50% of this category)
  • EPS Stability, defined as the standard deviation of EPS over the past 16 quarters, lower being better (50% of this category)

I began tracking this portfolio real-time on January 13th, 2012. As of this writing the portfolio is up 24.79% (including dividends) since inception. The portfolio has been hampered by big drawdowns in a handful of names, which the quantitative rules continue to define as undervalued. These are excellent examples of the challenges in value investing – a stock could be defined as under-valued for a good reason, and may remain so for a significant period of time, perhaps years or forever, if the company has experienced a permanent and material change in operations (a "value trap"). On the other hand, under-valued stocks may lag longer than investors wish, but patient, longer-term investors who aptly select value stocks can be rewarded in the long-run.

A real-world application of this portfolio could also utilize stop losses in order to prevent large drawdowns in single positions. However, for the purposes of tracking the portfolio results, all positions are bought and held until rebalancing. In July 2012 I added a rule to limit portfolio turnover – stocks will only be sold when they drop out of the top 20 in Graham Value screen. Thus, a stock could theoretically drop to the 20th ranking but remain in the 15 stock portfolio if it is a current holding.

Small cap and less liquid equities appear frequently on the list. This makes for a potentially more volatile, higher beta list of equities and also led to some early drawdowns in the portfolio. The screen excludes stocks with a market cap less than $100 million. Below are 5 and 10 year backtest results for this screen (with the $100 million market cap requirement) using a quarterly rebalance and .50% slippage to help account for bid/ask spreads and commission costs. The backtest also includes the rule to sell a stock only when it dropped out of the top 20 in the list:

(click to enlarge)

(click to enlarge)

The top 20 stocks based on the screen criteria are listed below:

HFCHollyFrontier Corp89.288653.64
CFCF Industries Holdings Inc88.411226.55
JOYJoy Global Inc86.975481.05
WDCWestern Digital Corp85.416241.12
AGIAlamos Gold Inc85.091709.35
TESSTESSCO Technologies Inc82.82246.43
AAPLApple Inc82.47401833.78
WMKWeis Markets Inc.81.41318.81
NATRNature's Sunshine Products Inc80.59281.76
HPHelmerich & Payne Inc.80.216943.93
RGLDRoyal Gold Inc77.372745.85
GOLDRandgold Resources Ltd77.295959.55
SCVLShoe Carnival Inc76.59525.18
SCLStepan Co76.261302.87
UNFUniFirst Corp74.511932.32
CUBCubic Corp74.071382.52
MRTNMarten Transport Ltd73.29584.68
IPARInter Parfums Inc72.221033.43
UVVUniversal Corp71.671435.42
SWMSchweitzer-Mauduit Intl Inc70.571669.15

Two stocks are being sold in this update:

SymbolNamePurchase Date% Gain/Loss
KNMKonami Corp1/15/201310.72%
AGUAgrium Inc.4/15/2013-1.62%

The two new additions are Royal Gold Inc (NASDAQ:RGLD) and Randgold Resources Ltd (NASDAQ:GOLD). Given the sell-off in gold and gold miners since late 2012, it should come as little surprise that we see two miners added to the portfolio.

The current portfolio is as of yesterday's close. Of note is the continued inclusion of Apple (NASDAQ:AAPL) and Western Digital (NASDAQ:WDC):

SymbolNamePurchase PricePurchase DatePercentage Gain/Loss
WDCWestern Digital44.841/15/201351.40%
AGIAlamos Gold Inc10.344/15/201332.21%
HFCHollyFrontier Corp45.94/15/2013-7.89%
MRTNMarten Transport Ltd18.794/15/2013-6.12%
NATRNature's Sunshine Products Inc14.094/15/201329.17%
HPHelmerich & Payne Inc.44.417/17/201244.88%
RGLDRoyal Gold Inc45.427/16/20130.00%
JOYJoy Global Inc52.714/15/2013-1.01%
CUBCubic Corp41.744/15/201323.38%
SWMSchweitzer-Mauduit Intl Inc33.6110/15/201257.39%
WMKWeis Markets Inc.38.691/15/201326.44%
GOLDRandgold Resources Ltd69.017/16/20130.00%
AAPLApple Inc419.854/15/20132.47%
TESSTESSCO Technologies Inc21.047/17/201244.53%
CFCF Industries Holdings Inc217.011/15/2013-16.52%

Disclosure: No positions