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8 Graham Stocks for 2012

Graham's time-tested strategy for defensive investors gained ground this year and beat the market once again. It also marks the ninth year of the last eleven in which the method has outperformed, which is a mighty fine showing.

The full performance record for the Graham stocks can be seen in Table 1 along with that of the S&P500 (as tracked by the SPY exchange-traded fund) and the percentage point difference between the two. If you had bought equal dollar amounts of the Graham stocks in your RRSP each year and replaced them with the new crop of stocks annually, you would have gained 517% (or 18% annually) over the full period. On the other hand, the unfortunate index investor who bought and held the S&P500 ETF (NYSE:SPY) would have gained a mere 0.3% (or basically 0% annually) over the same period. That even includes quarterly dividends reinvested annually. As you might imagine, I'm very pleased with the performance of my version of Graham's defensive strategy.

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
Total Gain 517.1% 0.3%516.8
Annualized 18.3% 0.0%18.3

Graham first described his method for defensive investors in The Intelligent Investor. While he passed away in 1976, an updated edition of The Intelligent Investor (ISBN 0060555661) with new commentary from veteran columnist Jason Zweig was published in 2003. Serious Graham buffs should also get a copy of the sixth edition of Security Analysis (ISBN 0071592539) which includes commentary from some of today's famous value investors. Just be warned, it can be a daunting volume for many.

I use a more moderate version of Graham's rules for defensive investors because the original rules are extraordinarily strict. My Graham-inspired rules 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 focus on five years worth of earnings growth instead of ten largely because it is easier to find the five-year figures.

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

Very few U.S. stocks usually pass my less-stringent version of Graham's rules. The annual list peaked at ten stocks in 2002 and bottomed out at two stocks in 2003. (As an aside, there were over forty stocks that passed the test back near the market lows in the spring of 2009.) This year, we're back up to eight stocks. Nonetheless, that's a small number compared to the thousands of stocks that trade each day. As a result, my version of the defensive approach remains quite strict.

The current list of Graham stocks is shown in Table 3. Before diving in, you should always examine any stock in great detail and remember that a well-diversified portfolio contains more than only a few stocks. You should also be on the look out for problems and intangibles that might not be reflected in a company's latest numbers. Study news stories, press releases, and regulatory filings.

While Graham's Defensive method has avoided serious long-term trouble, it can't be expected to outperform all of the time. After all, it has trailed the markets in two of the last eleven years. So, don't dive in based on past performance alone. Take your time and get comfortable with the method, and value investing more generally, before starting out because it can be harder to hold on through the ups and downs than you might expect.

TABLE 3: U.S. stocks that pass our Graham-inspired rules
CompanyPriceP/EP/BEPS GrowthCurrent RatioD/ERevenue ($M)Dividend Growth
ADM (ADM) $25.45 8.16 0.86 4.5% 2.1 0.44 80,676 9.0%
AVX Corp (AVX) $12.18 7.81 0.98 10.0% 6.7 0.00 1,653 7.0%
Blackrock (BLK) $147.78 12.18 1.15 14.5% 2.5 0.19 8,612 19.5%
Corn Products (CPO) $40.37 9.52 1.34 12.8% 2.3 0.73 4,367 12.8%
Curtis Wright (CW) $29.96 11.57 1.11 3.9% 2.4 0.37 1,893 5.7%
Freds (FRED) $11.09 14.04 1.02 4.1% 2.7 0.02 1,842 23.9%
Quaker Chemical (KWR) $27.44 8.71 1.33 22.2% 2.3 0.13 544 2.3%
Universal Corp (UVV) $38.01 7.37 0.89 18.2% 2.7 0.33 2,572 2.2%
Source: msn.com, zacks.com, morningstar.ca, October 8, 2011


Additional Resources:


First published in the November/December 2011 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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