| |
 |
  |
|
| Home News Articles Stocks DRPs Brokers Links Free Newsletters |
| Rothery Report: Login Learn More Performance Sample Subscribe Contact Us |
Timing Temptation
19 Stingy Stocks for 2009
4 Graham Stocks for 2009
Active at Passive Prices
Unbundling ETFs 2008
5 Stingy Stocks for 2008
5 Graham Stocks for 2008
Is your index too active?
Graham's Simple Way
Canadian Graham Stocks
5 Stingy Stocks for 2007
8 Graham Stocks for 2007
Top SPPs
The Simple Way
A hole in your IPO?
Monkey Business
8 Stingy Stocks for 2006
Graham Stock Gainers
Blue-Chip Blues
Are Dividends Safe?
SPPs for 2005
Graham's Simplest Way
Selling Graham Stocks
RRSP Money Market Funds
Stingy Stocks for 2005
High Performance Graham
Intelligent Indexing
Unbundling Canadian ETFs
A history of yield
A Dynamic Duo
Canadian Graham Stock
Dividends at Risk
Thrifty Value Stocks
Stocks in Short Supply
The New Dividend
Hunting Goodwill
SPPs for 2003
RRSP: don't panic
Desirable Dividends
Stingy Selections 2003
10 Graham Picks
Growth Eh?
Timing Disaster
Dangerous Diversification
The Coffee Can Portfolio
Down with the dogs
Stingy Selections
Frugal Funds
Graham Revisited
Just Spend It
Ticker Temptation
Stock Mortality
Focus on Fees
SPPs for the Long Term
Seeking Solid Stocks
Relative Strength
The VR Approach
The Irrational Investor
Value Investing
Eye on PI
MoneySense Articles
Income 100: 2009
The case for optimism
Income 2008
Small stocks, big profits
Cdn Top 200 2008
US Top 500 2008
Value that sizzles
So simple it works
Income 100
No assembly required
Investing by the book
Cdn Top 200 2007
US Top 500 2007
Invest like the masters
A simple way to get rich
Top Trusts 2006
Stocks for cannibals
Car bites dogs
Cdn Top 200 2006
US Top 1000 2006
So easy, so profitable
Top Trusts 2005
Dogs of the Dow
Top 200 2005
Money for nothing
Yield of dreams
Return of the master
Advisor's Edge Articles
Passive Rebundling
Doing the math
Norm Speaks
Warren Buffett's insurance company GEICO is currently running a series of humorous ads featuring the line, 'So easy even a caveman can do it'. In a curious twist of fate, Buffett's mentor Benjamin Graham developed a way to pick stocks that even cavemen would appreciate. Graham described his Simple Way in a 1976 article called The Simplest Way to Select Bargain Stocks that can be found in Janet Lowe's book The Rediscovered Benjamin Graham (ISBN 0471244724). Given its recent success, these days stock-picking cavemen are dining out on mammoth steak.
Indeed, stocks selected by Graham's Simple Way gained an average of 26.6% over the last year which bests a 20.8% advance for the S&P500 as represented by the SPY exchange-traded fund. (In both cases dividends are included but not reinvested.) That's an outperformance of 5.8 percentage points for the Simple Way. Since 2005 Graham's method did even better with a 54.0% gain that outpaced the SPY fund by 19.8 percentage points. Not bad for a technique that has been around for more than 40 years.
Graham's Simple Way is based on two main criteria. First, stocks must have an earnings yield that is at least twice as large as the average yield on long-term AAA corporate bonds. Furthermore, Graham thought investors should not buy stocks with earnings yields of less than 10%.
Earnings yield is the reciprocal of the more common price-to-earnings ratio. Instead of dividing price by earnings, as you do for P/E ratios, earnings yield is found by dividing earnings by price and the result shown as a percentage. So, if a stock earned $1 per share last year and is trading at $20 per share then its earnings yield would be 5% (i.e. $1 / $20 * 100%).
The average yield on AAA 20-year U.S. corporate bonds was 6.01% on June 1, 2007. So, according to the Simplest Way a stock is cheap if it has an earnings yield of more than 12.02% (or a positive P/E ratio of less than 8.32).
Graham's second requirement focused on safety by demanding that companies have little debt. He stuck to stocks with leverage ratios (the ratio of total assets to shareholder's equity) of two or less. Although low-debt firms are relatively safe, it is important to remember that there is no such thing as a totally safe stock.
When it came to selling, Graham suggested waiting for either a 50% profit or no later than the end of the second calendar year after purchase. On this point I differ from Graham in that I'm willing to let my winners run. However, Graham's admonition to trim one's losers is good to keep in mind. Nonetheless, to make performance calculations less onerous, I assume that stocks are held between articles (which appear about once a year) and are then replaced by new stocks.
This year Graham's criteria narrowed the large universe of stocks down to 179. But I decided to focus on U.S. stocks with market capitalizations of more than $500 million (down from a billion dollars last year), which are shown in Table 1. Even after including a few smaller stocks, the list is down to 11 stocks this year from 22 last year.
When looking at the list, you should keep in mind that some stocks will inevitably fair poorly. For instance, the biggest dog from last year was Louisiana-Pacific Corp (LPX) which lost 16.9%. Indeed, 7 of the 22 stocks from last year lost money. While losses were more than made up for by big gains elsewhere, owning a portfolio of value stocks can be stressful for some investors.
I have high hopes that Graham's method will continue to do well in the long run. But demonstrate that you're smarter than a caveman and use Graham's list as a starting point for further research and not the final destination. As always, dig deeper and do your own homework before investing.
| Table 1: Graham's Simple Stocks | ||||||
| Company | Industry | Market Cap ($M) | Price ($) | P/E | Leverage Ratio | Div. Yield (%) |
| Valero Energy(VLO) | Oil & Gas | 41,657 | $75.88 | 8.3 | 2.0 | 0.6% |
| American Capital(ACAS) | Diversified Investments | 7,822 | $48.42 | 8.0 | 1.9 | 7.5% |
| Patterson-UTI Energy (PTEN) | Oil & Gas | 4,129 | $26.35 | 6.9 | 1.3 | 1.8% |
| IPC (IPCR) | Life Insurance | 1,997 | $31.37 | 5.5 | 1.4 | 2.6% |
| Kaiser Aluminum (KALU) | Metals & Minerals | 1,541 | $74.88 | 1.8 | 1.6 | 0.0% |
| Calumet Specialty Products (CLMT) | Oil & Gas | 1,517 | $51.53 | 6.8 | 1.6 | 4.7% |
| Grey Wolf (GW) | Oil & Gas | 1,475 | $7.98 | 7.9 | 2.0 | 0.0% |
| BP Prudhoe Bay RT (BPT) | Diversified Investments | 1,431 | $66.86 | 7.9 | 1.1 | 11.0% |
| Flagstone Reinsurance (FSR) | P&C Insurance | 1,125 | $13.19 | 6.1 | 1.6 | 0.0% |
| Encore Wire (WIRE) | Electrical Equipment | 696 | $29.82 | 6.7 | 1.5 | 0.3% |
| Avatar (AVTR) | Residential Construction | 680 | $82.00 | 5.4 | 1.4 | 0.0% |
| Source: MSN.com, June 1, 2007 | ||||||
First published in the July/August 2007 magazine.
|
|
| About Legal | Contact Us |