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Flip Books



4 Graham Stocks for 2014

It is my pleasure to present you with the annual list of Graham stocks for 2014. These stocks pass my take on Benjamin Graham's test for defensive investors which focuses on relatively stable firms that trade at bargain prices.

I'm also pleased to say that the method has been highly profitable over the long term. However, it did trail the market, by a smidgeon, last year with a 19% return. You can see the full performance record in the accompanying table.

TABLE 1: Performance of Past Graham Stocks
YearGraham S&P500 +/-
2000 - 2001 20.4% -22.2% 42.6
2001 - 2002 28.2% -15.1% 43.3
2002 - 2003 56.8% 16.5% 40.3
2003 - 2004 32.2% 9.4% 22.8
2004 - 2005 46.6% 12.8% 33.8
2005 - 2006 -3.8% 10.7% -14.5
2006 - 2007 34.4% 16.1% 18.3
2007 - 2008 -6.5% -22.1% 15.6
2008 - 2009 2.2% -6.2% 8.4
2009 - 2010 2.3% 9.1% -6.8
2010 - 2011 4.1% 3.1% 1.0
2011 - 2012 26.6% 27.9% -1.3
2012 - 2013 19.0% 19.1% -0.1
Total Gain 830% 53%

If you had bought equal dollar amounts of the Graham stocks and replaced them with the new batch each year, you would have gained 830% (or 19% annualized) over the full period. On the other hand, index investors who bought and held the S&P500 ETF (NYSE:SPY) would be up only 53% (3% annualized) over the same period. Needless to say, the difference is considerable. (In both cases U.S. dollar returns are shown, which include dividends that are reinvested each year when the new stocks are selected.)

You can read all about Graham's original method for defensive investors in his book The Intelligent Investor. While he passed away in 1976, an updated edition of The Intelligent Investor (ISBN 0060555661), with modern commentary from veteran columnist Jason Zweig, was published in 2003. It's worth picking up. Serious Graham buffs should also invest in a copy of the sixth edition of Security Analysis (ISBN 0071592539), which includes additional commentary from some of today's most famous value investors. But, be warned, the second book can be a little daunting for new investors.

Graham's original rules for defensive investors were very strict. So strict that you wouldn't have found any North American stocks with them for much of the last decade. That's why my version employs a slightly more lenient approach. The important criteria I use are shown in the accompanying list, which reflects Graham's main requirements with a few modifications.

TABLE 2: Graham-inspired rules
1. P/E Ratio less than 15
2. P/Book Ratio less than 1.5
3. Positive Book Value
4. Current Ratio more than 2
5. Annual EPS Growth (5-Yr Avg) more than 3%
6. Positive 5 Year Dividend Growth
7. Positive Annual Earnings for 5 Years
8. 1-Year Revenue more than $400 Million

For instance, I differ when it comes to the dividend test. Graham demanded a twenty-year record of uninterrupted dividend payments whereas I require some dividend growth over the last five years. Problem is, there are very few firms that have good twenty-year dividend records.

Even with my slightly more lenient rules, very few U.S. stocks usually pass the test. At market lows, such as those seen in the spring of 2009, dozens might be available. More usually, less than 10 companies make the grade. This year only four made it. They are shown in the accompanying table.

However, a well-diversified portfolio should hold more than 10 stocks and in most cases many more. As a result, if you're keen on the defensive stocks then please use them to supplement a more diversified portfolio.

Before buying any stock, be sure to examine it in great detail. After all, the less tangible aspects of each company are worth considering. Also, keep an eye out for issues that might not be reflected in the company's latest numbers and get up to speed by reading news stories, press releases, and regulatory filings.

While my take on Graham's defensive method has avoided serious trouble so far, it can't be expected to outperform all of the time. Despite its resounding long-term track record, it trailed the market in four of the last thirteen years.

Be sure to take your time to get comfortable with the method, and value investing more generally, before diving in. It might look easy, but it can be hard to stick with value stocks as they go through their ups and downs.

TABLE 3: U.S. stocks that pass my Graham-inspired rules
Name Price P/E P/B Yield
American Financial (AFG) $54.67 10.0 1.1 1.61%
HollyFrontier (HFC) $41.83 5.4 1.3 2.87%
Universal (UVV) $51.16 8.7 1.1 3.91%
Unum (UNM) $30.83 9.4 1.0 1.88%
Sources: msn.com, yahoo.com, morningstar.ca, October 1, 2013


Additional Resources:


First published in the January 2014 edition of the Canadian MoneySaver magazine. Performance numbers are based on the dates in the data table and do not represent calendar year figures.

 
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