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A Simplified Approach To Value: A 1-Year Test Of Graham's Number On S&P 500 Stocks

by: Clestian Andrieux
Summary

Start of a year-long assessment of monthly, non-discretionary asset allocation based on programmatic Graham Number valuations.

Trades to be tracked using Investopedia's stock exchange game platform (Investopedia Game 2018 No End).

Non-discretionary Graham Number based asset allocation will bear some risk not associated with intended application of Graham Number.

Investing in undervalued S&P 500 stocks should outpace the index.

Most readers of SA will already have some familiarity with the work of Benjamin Graham. Pertaining to this post (and the series I intend on writing following it), I'll be misusing a formula which has become so synonymous with his name that it shares his name: The Graham number.

This post, and a series of follow up articles I'll be writing over the next year, will document the performance of a virtual portfolio I'll be trading in via the Investopedia Stock Exchange game platform. For those wishing to view portfolio performance directly, participation in the game is necessary (participation requires creating a free account with Investopedia).

Methodology

As mentioned above, for this trading plan, I'm not using the Graham number as intended. In The Intelligent Investor, Benjamin Graham advises the defensive investor to follow a selection plan which includes 7 minimum criteria an investor should follow, two of which are a price which does not exceed 150% of book value and a price which does not exceed 15 times earnings (chapter 14, Graham). Of course, this still leaves 5 guidelines that we are not following here--minimum debt to asset ratios (no more than 1:1 for long-term debt), minimum annual sales, positive earnings (my own screen looks for this, however, Graham suggests going back 10 years), dividends (going back 20 years), and consistent per-share earnings.

My goal is to demonstrate a partial implementation of the formula which:

  1. I believe will outperform the market (specifically the S&P 500 index) over the long term.
  2. Is extremely simple in implementation and should require minimal maintenance or management.
  3. Can be maintained solely during non-trading hours, allowing an investor to walk away to a "day job".
  4. Can be managed completely through free sources, leaving any overhead only from brokerage and/or government fees.

Process

During the first weekend of each month, I'll perform a screen using the screener at zacks.com using the following criteria:

  • Member of the S&P 500 index
  • 12 Month Trailing EPS >= $0.01
  • Book Value / share >= $0.01
  • Net Income >= $0.01
  • Last Close >= $0.01

For the first weekend of May 2018, here are the companies trading below their Graham number:

Company Name Ticker Last Close 12 Mo Trailing EPS Book Value Graham number % diff
Navient Corporation NAVI 13.48 1.81 13.86 23.75812493 76.25%
Prudential Financial, Inc. PRU 100.66 10.87 123.64 173.8943731 72.75%
Ford Motor Company F 11.36 1.81 9.17 19.32480918 70.11%
MetLife, Inc. MET 46.23 4.86 55.47 77.88224766 68.47%
Unum Group UNM 39.86 4.51 42.93 66.00243745 65.59%
Lincoln National Corporation LNC 68.95 7.83 73.24 113.5916238 64.74%
Capital One Financial Corporation COF 89.06 8.69 101.18 140.6528332 57.93%
Newell Brands Inc. NWL 27.65 2.75 28.94 42.31622029 53.04%
CenturyLink, Inc. CTL 18.49 1.58 21.98 27.95333612 51.18%
Range Resources Corporation RRC 13.62 0.79 23.41 20.39884188 49.77%
The Goodyear Tire & Rubber Company GT 25.28 2.9 20.69 36.74265233 45.34%
Kimco Realty Corporation KIM 14.67 1.51 12.95 20.97561084 42.98%
Micron Technology, Inc. MU 47.58 8.91 22.91 67.77080677 42.44%
Xerox Corporation XRX 28.38 3.48 20.79 40.3467099 42.17%
Western Digital Corporation WDC 77.28 14.07 37.97 109.6373693 41.87%
Mylan N.V. MYL 35.98 4.56 24.81 50.45300784 40.23%
The Goldman Sachs Group, Inc. GS 234.94 21.6 221.12 327.8175102 39.53%
Loews Corporation L 50.97 2.94 74.68 70.2857169 37.90%
Invesco Ltd. IVZ 28.39 2.75 22.57 37.37002475 31.63%
AT&T Inc. T 32.14 3.16 23.95 41.26554253 28.39%
Viacom Inc. VIAB 30.29 3.89 17.02 38.59631459 27.42%
Macy's, Inc. M 31.24 3.77 18.59 39.71015928 27.11%
Molson Coors Brewing Company TAP 60.48 4.1 63.39 76.47043546 26.44%
Citizens Financial Group, Inc. CFG 41.03 2.8 40.65 50.6058297 23.34%
Principal Financial Group, Inc. PFG 57.15 5.18 42.58 70.44642645 23.27%
Pacific Gas & Electric Co. PCG 44.88 3.52 37.85 54.75143834 22.00%
The Kraft Heinz Company KHC 58.01 3.6 58.3 68.71899301 18.46%
Hewlett Packard Enterprise Company HPE 17.21 1.19 15.31 20.24661083 17.64%
Morgan Stanley MS 51.4 4.09 39.12 60.00015 16.73%
Leucadia National Corporation LUK 24.45 1.25 28.88 28.5 16.56%
CVS Health Corporation CVS 63.1 6.23 38.12 73.09904924 15.85%
Lennar Corporation LEN 54.44 4.37 40.45 63.06541247 15.84%
Exelon Corporation EXC 41.08 2.9 33.74 46.9205179 14.22%
Wells Fargo & Company WFC 52.41 4.2 37 59.13121003 12.82%
Franklin Resources, Inc. BEN 32.86 3.15 19.26 36.9466169 12.44%
Aflac Incorporated AFL 44.81 3.62 31.16 50.37838822 12.43%
Bank of America Corporation BAC 29.3 2.03 23.58 32.81792955 12.01%
The Allstate Corporation ALL 94.52 8.03 59.67 103.8310033 9.85%
People's United Financial, Inc. PBCT 18.41 1.1 16.14 19.98662052 8.56%
EQT Corporation EQT 48.63 1.95 63.52 52.79147658 8.56%
Freeport-McMoRan Inc. FCX 15.42 1.48 8.24 16.56478192 7.42%
Synchrony Financial SYF 32.63 2.84 19.02 34.86227187 6.84%
Welltower Inc. WELL 56.18 4.15 38.58 60.02005915 6.84%
Pentair plc PNR 44.3 3.76 26.46 47.31295806 6.80%
Express Scripts Holding Company ESRX 70.22 7.56 32.85 74.75148828 6.45%
The Bank of New York Mellon Corporation BK 54.49 3.91 38.03 57.84193332 6.15%
Chubb Limited CB 132.75 7.88 110.51 139.9765087 5.44%
SL Green Realty Corporation SLG 99.92 6.53 75.3 105.1829478 5.27%
Foot Locker, Inc. FL 41.67 4.11 20.78 43.8364061 5.20%
Entergy Corporation ETR 82.2 7.38 44.12 85.59279175 4.13%
SunTrust Banks, Inc. STI 66.6 4.47 47.5 69.11810544 3.78%
Johnson Controls International plc JCI 36.25 2.65 23.63 37.53583288 3.55%
Affiliated Managers Group, Inc. AMG 161.72 15.34 81.15 167.3586643 3.49%
KeyCorp KEY 19.7 1.4 13.13 20.33703518 3.23%
PPL Corporation PPL 28.95 2.37 16.1 29.30072525 1.21%
TechnipFMC plc FTI 33.24 1.75 28.74 33.63982015 1.20%
Carnival Corporation CCL 63.57 3.96 45.65 63.7762887 0.32%
Huntington Bancshares Incorporated HBAN 14.7 1.05 9.17 14.71873806 0.13%

Here are the trades inputted to the Investopedia game on the same weekend:

Investopedia pending trades Initial Observations

The first implementation of this screen resulted in 58 candidates for purchase (all screened stocks resulting in an undervalued condition; priced below their respective Graham number). For sake of simplicity, assuming no fractional values of shares to be held, assets were balanced as equally as possible.

There is likely a great deal of diversity reducing asset overlap as a number of the assets purchased are in the investment/financial services sector. Since this is a non-discretionally approach for this experiment--I'm allowing the sighted criteria to decided whether or not a stock will be held, regardless of other concerns; other approaches may attempt to more effectively diversify.

Also of note, Ford Motor Company (F), which I've written about in the past, shows up on the list to the tune of a 70% undervaluation (currently priced at around $11.50, Graham number > $19).

Simplicity being the goal here, assets will not be re-balanced. Instead, as they reach an overvalued state, they will be sold, proceeds to go to the balanced purchase of currently undervalued assets.

Follow-up articles will review such changes as well as reviewing the performance of various assets being held. I'll be aiming for a brief write up on 3 stocks.

Disclosure: I am/we are long F. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.