Graham Value Stock Portfolio Update

by: Scott's Investments

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:

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

Ticker Name Rank MktCap
HFC HollyFrontier Corp 89.28 8653.64
CF CF Industries Holdings Inc 88.4 11226.55
JOY Joy Global Inc 86.97 5481.05
WDC Western Digital Corp 85.4 16241.12
AGI Alamos Gold Inc 85.09 1709.35
TESS TESSCO Technologies Inc 82.82 246.43
AAPL Apple Inc 82.47 401833.78
WMK Weis Markets Inc. 81.4 1318.81
NATR Nature's Sunshine Products Inc 80.59 281.76
HP Helmerich & Payne Inc. 80.21 6943.93
RGLD Royal Gold Inc 77.37 2745.85
GOLD Randgold Resources Ltd 77.29 5959.55
SCVL Shoe Carnival Inc 76.59 525.18
SCL Stepan Co 76.26 1302.87
UNF UniFirst Corp 74.51 1932.32
CUB Cubic Corp 74.07 1382.52
MRTN Marten Transport Ltd 73.29 584.68
IPAR Inter Parfums Inc 72.22 1033.43
UVV Universal Corp 71.67 1435.42
SWM Schweitzer-Mauduit Intl Inc 70.57 1669.15

Two stocks are being sold in this update:

Symbol Name Purchase Date % Gain/Loss
KNM Konami Corp 1/15/2013 10.72%
AGU Agrium 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 (NYSE:WDC):

Symbol Name Purchase Price Purchase Date Percentage Gain/Loss
WDC Western Digital 44.84 1/15/2013 51.40%
AGI Alamos Gold Inc 10.34 4/15/2013 32.21%
HFC HollyFrontier Corp 45.9 4/15/2013 -7.89%
MRTN Marten Transport Ltd 18.79 4/15/2013 -6.12%
NATR Nature's Sunshine Products Inc 14.09 4/15/2013 29.17%
HP Helmerich & Payne Inc. 44.41 7/17/2012 44.88%
RGLD Royal Gold Inc 45.42 7/16/2013 0.00%
JOY Joy Global Inc 52.71 4/15/2013 -1.01%
CUB Cubic Corp 41.74 4/15/2013 23.38%
SWM Schweitzer-Mauduit Intl Inc 33.61 10/15/2012 57.39%
WMK Weis Markets Inc. 38.69 1/15/2013 26.44%
GOLD Randgold Resources Ltd 69.01 7/16/2013 0.00%
AAPL Apple Inc 419.85 4/15/2013 2.47%
TESS TESSCO Technologies Inc 21.04 7/17/2012 44.53%
CF CF Industries Holdings Inc 217.01 1/15/2013 -16.52%

Disclosure: No positions