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Flip Books



8 Graham Stocks for 2007

Over the past six years I've used Benjamin Graham's time-tested strategy for defensive investors to uncover undervalued U.S. stocks. Overall the results have been stellar but last year the method hit a speed bump and posted a small loss.

The performance of each year's Graham stocks, the performance of the S&P500 (as tracked by the SPY exchangetraded fund) and the difference between the two is shown in Table 1. You can see that the Graham stocks have beaten the S&P500 in five of the last six years and often by a large margin. An investor who bought each year's Graham stocks, sold, and then bought the next crop of stocks would have gained 351% (or 30% annually - based on the total number of days since the first article was written) whereas a buy and hold investment in SPY units would have gained only 1%.

TABLE 1: PERFORMANCE OF PAST GRAHAM STOCKS
Year*Graham S&P500 +/-
2000 - 200120.4%-22.2%42.6
2001 - 200228.2%-15.1%43.3
2002 - 200356.8%16.5%40.3
2003 - 200432.2%9.4% 22.8
2004 - 2005 46.6% 12.8% 33.8
2005 - 2006 -3.8% 10.7% -14.5
Overall 351.4% 1.0%
* Indicates the time between articles and not calendar years.


Graham described his method for defensive investors in his book The Intelligent Investor, which has been in bookstores for more than fifty years. An updated edition of The Intelligent Investor (ISBN:0060555661) with new commentary from veteran Money magazine columnist Jason Zweig is now in bookstores and the original text is thankfully presented in its entirety. Zweig's commentary is thoughtfully separated from Graham's work and is placed in copious footnotes at the end of each chapter. If you don't already have a copy of The Intelligent Investor, then this is the version to get. Serious investors will try to buy the book at a sharp discount to intrinsic value through their local used bookstore.

Because Graham's original rules for defensive investors are very stringent, I've used a slightly looser version and my Graham-inspired requirements are shown in Table 2. For example, I require some dividend growth over the last five years whereas Graham demanded a twenty-year record of uninterrupted dividend payments. Similarly, I decided to focus on five-year earnings growth instead of ten-year earnings growth largely because five-year growth is easily found in many free Internet stock screeners. This year I tweaked my criteria slightly by rounding off the annual earnings growth requirement to 3%, a very modest change, which didn't impact this year's list in the slightest.

TABLE 2: GRAHAM-INSPIRED RULES
1. P/E Ratio less than 15
2. P/Book Ratio less than 1.5
3. Book Value more than 0.01
4. Current Ratio more than 2
5. Annual EPS Growth (5-Yr Avg) more than 3%
6. 5-Year Dividend Growth more than 0%
7. 5-Year P/E Low more than 0.01
8. 1-Year Revenue more than $400 Million


Even with my less stringent version of Graham's rules, very few stocks usually pass the test. I found only nine U.S. Graham stocks in 2000, five in 2001, ten in 2002, two in 2003, five in 2004, and three in 2005. This year the selection has expanded nicely with eight stocks passing the test out of thousands of potential candidates.

The current crop of Graham stocks is shown in Table 3. It is a good idea to look for some indication that the situation has remained largely unchanged before buying because of the time lag between my analysis and the article's publication. Similarly, be on the lookout for recent problems that might not be reflected in a company's latest numbers by reviewing news stories, press releases, and regulatory filings.

TABLE 3: U.S. STOCKS THAT PASS GRAHAM-INSPIRED RULES
CompanyPrice ($)P/EP/E 5-Yr LowP/BAnnual EPS Growth (%)Current RatioD/E1-Yr Revenue ($M)5-Yr Dividend Growth (%)
Blair (BL) 25.24 5.1 5.1 0.83 8.4 2.7 0.00 464 4.6
Briggs & Stratton (BGG) 27.66 14.0 9.1 1.43 16.3 3.0 0.39 2,542 7.3
Seaboard (SEB) 1,245 6.1 2.1 1.43 97.5 3.4 0.22 2,563 24.6
Media General (MEG) 38.10 14.8 11.0 0.95 5.3 2.5 0.49 914 5.6
Teekay Shipping (TK) 41.78 10.5 3.1 1.29 16.22.0 1.10 1,906 7.6
Overseas Shipholding (OSG) 62.91 6.6 3.2 1.21 40.1 2.5 0.39 1,008 3.1
Gibraltar Industries (ROCK) 22.70 12.3 8.9 1.27 12.9 2.5 0.68 1,291 21.1
Schnitzer Steel (SCHN) 32.06 7.8 3.8 1.45 69.9 2.9 0.16 1,446 0.4
Source: msn.com, September 27, 2006


You should examine any stock in great detail before investing and remember that eight stocks can't be said to form a well-diversified portfolio. Always be cautious before jumping into any investment and talk over potential purchases with your investment advisor. (For the sake of full disclosure, these Graham stocks may be in our personal and client portfolios.)

Remember that value stocks can be psychologically difficult to hold and a few beaten-up stocks inevitably fail entirely. Graham's method has avoided running into any serious trouble but, as this year's results have shown, it can't be expected to outperform all of the time. Indeed, significant periods of underperformance are likely. I'm particularly concerned that some readers might dive right in based on past performance alone. Don't. Be sure that you understand what you're investing in and focus at least as much on what can go wrong as on what might go right.

Additional Resources:

First published in the November 2003 edition of the Canadian MoneySaver magazine.

 
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