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6 Graham Stocks for 2013

My version of Benjamin Graham's time-tested strategy for defensive investors yielded double digit gains this year. Let's take a look at the method, how it has done over the long term, and this year's group of Graham stocks.

You can see the full performance record for my take on Graham's strategy in the accompanying table. I'm happy to report that it has outperformed the S&P500 (as represented by the SPY exchange-traded fund) in nine of the last twelve years and often by a large margin.

If you had bought equal dollar amounts of the Graham stocks and replaced them with the new crop of stocks each year, you would have gained 681% (19% annualized) over the full period. On the other hand, the unfortunate index investor who bought and held the S&P500 ETF (NYSE:SPY) would be up only 28% (2% annualized) over the same period. (These results are in U.S. dollars, do not include taxes, but do include dividends reinvested each year when the new stocks are selected.) As you might imagine, I'm very pleased with the returns so far.

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
Total Gain 681% 28%

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 and it is definitely worth picking up. I hasten to add that serious Graham buffs should also get a copy of the sixth edition of Security Analysis (ISBN 0071592539) which includes additional commentary from some of today's most famous value investors. Just be warned, it's a thick volume that can be daunting.

Graham's original rules for defensive investors were very strict. So strict that you'd have been hard pressed to find any North American stocks with it for much of the last decade. As a result, I took a slightly more lenient approach. The factors I look for are shown in the accompanying list.

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

To highlight one way that I differ from Graham, consider the dividend test. I require some dividend growth over the last five years whereas Graham demanded a twenty-year record of uninterrupted dividend payments. However, there are very few firms with good 20-year dividend records and requiring them narrows the universe of stocks under consideration dramatically.

Despite the different rules, very few U.S. stocks usually pass my version of Graham's test. The annual list peaked at ten stocks in 2002 and quickly bottomed out at two stocks in 2003. (As an aside, I track the list more frequently and found over forty stocks that passed the test when the market hit its lows in the spring of 2009.) This year, the list slipped down to six stocks as the U.S. markets moved higher.

I hasten to add that a well-diversified portfolio should hold more than 10 stocks and in most cases much more. As a result, Graham's list should be supplemented with other stocks to avoid under-diversification.

You can review the current crop of Graham stocks in the accompanying table. But before buying any of them, be sure to examine each stock in great detail. After all, the method is based entirely on the numbers and less tangible aspects of each company are also worth considering. Look for issues that might not be reflected in a company's latest numbers and get up to speed by reading news stories, press releases, and regulatory filings.

While Graham's Defensive method has avoided serious trouble so far, it can't be expected to outperform all of the time. After all, it has trailed the markets in three of the last twelve years. So, don't get lured into it based on past performance alone.

It is also important to take your time to get comfortable with the method, and value investing more generally, before starting out. It might look easy, but it can be harder than you might expect to hold on as value stocks go through their ups and downs.

TABLE 3: U.S. stocks that pass my Graham-inspired rules
CompanyPriceP/EP/BEPS GrowthCurrent RatioD/ERevenue ($M)Dividend Growth
BlackRock(BLK) $181.57 14.94 1.27 15% 2.88 0.31 8,930 20%
Corning(GLW) $13.38 9.42 0.93 6% 4.96 0.15 7,790 8%
Fred's(FRED) $14.10 13.17 1.21 13% 2.49 0.02 1,913 32%
HollyFrontier(HFC) $39.36 5.50 1.49 23% 2.37 0.24 19,884 15%
Universal(UVV) $52.25 10.49 1.26 5% 3.66 0.47 2,429 2%
Weis(WMK) $41.83 14.18 1.45 13% 2.14 0.00 2,755 1%
Source: msn.com, zacks.com, morningstar.ca, October 3, 2012


Additional Resources:


First published in the November/December 2012 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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