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Graham Stocks in Short Supply
Over the past three years, I've used Benjamin Graham's time-tested strategy for defensive investors to uncover undervalued stocks. So far, the results have been extraordinary with significant gains each year. Benjamin Graham first outlined his rules for defensive investors in The Intelligent Investor which has been in bookstores for more than fifty years. For those new to Graham, an updated edition of The Intelligent Investor (ISBN 0060555661) was released this summer with a forward by noted financial journalist Jason Zweig. Despite Zweig's sterling prose, the intelligent book buyer should consider picking up an inexpensive used copy. Graham's rules for defensive investors are briefly summarized in Figure 1. Each year only a few stocks meet Graham's stringent rules for earnings growth at a low price and his method often rejects all stocks as unsuitable. Rejection has certainly been the rule in recent times and the situation is even worse this year.
To implement Graham's rules I use the MSN.com stock screener which does a reasonably good job; but the screener doesn't have the wealth of historical data needed to fully implement Graham's rules. For instance, the MSN.com database only contains five years of data on each stock and, as a result, I trimmed down Graham's rules to those shown in Figure 2. Even with these relaxed rules, only nine stocks passed all tests in 2000, five in 2001, and ten in 2002. Regrettably, only two stocks passed the test this year. To put this in perspective, there are currently over 6,600 stocks in the MSN.com database.
The nine picks of 2000 continue to do well with seven stocks gaining ground and only two losing. A stock by stock breakdown is shown in Table 1 with the average gain for these stocks a very healthy 107.3%. Given that the S&P500 fell by 22.2% over the same period, the Graham stocks managed a remarkable outperformance of 129.5 percentage points over three years. I should hasten to add, that outperforming the index by such a large margin should in no way be considered typical, or even expected.
It turns out that the five picks of 2001 also boasted extraordinary performance with an average gain of 99.4%. Table 1 shows that the worst individual performer gained over 42% and the best 164%. The S&P500, on the other hand, fell 1.4% over the same period, which translates into superior outperformance of 100.8 percentage points for the 2001 Graham picks. Last year's picks were also strong performers with an average gain of 55.8%. Table 1 shows that individual stocks gained between 12.3% and 93.3%. The S&P500 trailed the Graham stocks by 40.5 percentage points and gained only 16.3% over the same period. Clearly Graham's defensive approach has done quite well but such results are unlikely to continue. It has been my experience that periods of significant outperformance are usually followed by periods of severe underperformance. Be warned that buying into a style that has recently done well is no guarantee that it will continue to do well. This year's crop of Graham stocks is shown in Table 2. Since stocks tend to move very rapidly, I suggest checking the MSN.com screener to be sure that the stocks in Table 2 continue to fit Graham's criteria.
It is important to note that stock screeners can be deceptive at times because they aren't always up to date. For example, if a company suffers from a sudden calamity then the stock may continue to be highlighted as good pick based on old data. One often finds stocks that look good in a stock screener but aren't good for a portfolio. I usually like to see some indication that a company's situation has remained largely unchanged before buying. For instance, looking at recent news stories on the company often helps. This year the pickings are slim with only two Graham stocks. Naturally, investing in only two stocks is not recommended. Furthermore, deep value picks can be psychologically difficult for many investors. So, if you are considering stocks, remember Warren Buffett's admonition that "Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market." Additional Resources:
First published in the November 2003 edition of the Canadian MoneySaver magazine. |
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| Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More... | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
