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10 Graham Picks for 2003

December is filled with family, friends, and, for investors, the dreams of healthy dividends. In what has become a December tradition, I look at Benjamin Graham's strategy for defensive investors using the stock screener. Long-time Canadian MoneySaver readers will note that this is the third time I've discussed Graham's conservative technique.

Benjamin Graham first outlined his rules for defensive investors in The Intelligent Investor (ISBN 0060155477) which has been in bookstores for more than fifty years. I've breifly summarized Graham's time-tested rules in Figure 1. Usually 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 has not changed much this year despite overall market weakness.

Implementing Graham's rules can be tricky but the screener does a reasonably good job of approximating them. The problem is that's screener doesn't have the wealth of historical data needed to fully implement Graham's rules for defensive investors. For instance, the database only contains five years of data on each stock and, as a result, I've trimmed down Graham's rules as shown in Figure 2. Even with these relaxed rules only nine stocks passed all the tests in 2000, five in 2001 and ten this year. To put this in perspective, there are currently over 6,900 stocks in the database.

The nine picks of 2000 continued to do well with five in the plus column and four losing ground to date. The stock by stock breakdown is shown in Table 1 and the average gain for these stocks was very healthy at 35.86%. Given that the S&P500 fell by 33.85% over the same period, the Graham stocks managed a remarkable outperformance of 69.71% over two years. I should hasten to add, that outperforming the index by almost 70% should in no way be considered typical, or even expected.

It turns out that the five picks of 2001 also performed well with an average gain of 28.24%. Table 2 shows that the individual stocks gained between 8.67% and 56.51%. The S&P500, on the other hand, fell 16.05% over the same period, which translates into an outperformance of 44.29% from the 2001 Graham picks.

Clearly Graham's defensive approach has done quite well in the bear market. However, it has been my experience that periods of significant outperformance are often followed by periods of severe underperformance. Be warned that buying into a style that has recently done very well is no guarantee that it will continue to do well. Past performance is usually a poor indicator of future performance.

The current crop of Graham stocks is shown in Table 3. We all know that stocks can move very rapidly in today's volatile environment and I suggest using the screener to be sure that the stocks in Table 3 still 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, consider a company with steady earnings that suffers from some sudden calamity. Say its main manufacturing facility is demolished by a tornado. In this case, the stock may be labeled by the stock screener as good pick due to its recent quarterly numbers. However, the company's situation has clearly changed for the worse. In this way one often finds stocks that look good on the screener but aren't good for a portfolio. As a result, I often like to see some indication that a company's situation has remained largely unchanged before buying. Looking at recent news stories on the company can often help the investor avoid the stinkers. It is important to try to select stocks that are simply unloved and avoid those heading for the dumpster.

Looking at this year's crop of Graham stocks one quickly notices that many homebuilders and related companies fill the list. The dominance of this hot sector is particularly troubling. Granted, interest rates are at historic lows and first-time buyers are flooding the real estate market but many fear that another bubble is growing in real estate. If interest rates climb or the economy continues to weaken then the housing market could go from boom to bust and take this year's Graham stocks down significantly. Furthermore, these stocks are not suitable for all portfolios. Be sure to talk to your advisor before investing. Once again, buyer beware.

Figures & Tables

Figure 1: Benjamin Graham's Criteria for the Defensive Investor
P/E Ratio less than 15.
P/Book Ratio less than 1.5.
Book Value over 0.
Current Ratio over 2.
Earnings growth of 33% over 10 years.
Uninterrupted dividends over 20 years.
Some earnings in each of the past 10 years.
Annual revenue of more than $100 Million (1950).
Source: The Intelligent Investor (pages 184-185).

Figure 2: Screening criteria used to approximate Graham's rules
P/E Ratio less than 15.
P/Book Ratio less than 1.5.
Book Value more than 0.01.
Current Ratio more than 2 .
5 Year Earnings Growth more than 15%.
5 Year Dividend Growth more than 0%.
5 Year P/E Low more than 0.01.
1 Year Revenue more than $400 Million.

Table 1: Performance of the 2000 Picks (12/12/00 to 10/27/02)
Company2000 Price2002 PriceTotal Return
AAR Corp (AIR)$11.94$3.98-63.40%
Haverty Furniture (HVT)$10.06 $13.7039.76%
La-z-boy (LZB)$15.88$24.5258.50%
Rollins Truck (RLC)-bought out in 2001-82.00%
Reliance Steel (RS)$25.13 $20.65-16.16%
Tredegar Corp (TG)$15.56$12.25-19.47%
Thor Industries (THO)$19.69$34.12*247.38%
Wabash National (WNC)$7.81$4.65-38.80%
Watsco (WSO)$11.35 $14.8532.95%
Average Gain:+35.86%
S&P 500 (SPY):-33.85%
Source:, * Adjusted for a 2-to-1 split

Table 2: Performance of the 2001 Picks (10/29/01 to 10/27/01)
Company2001 Price2002 PriceTotal Return
Centex (CTX)$39.45$46.4918.25%
Domtar (DTC)$8.19$9.6820.15%
Haverty Furniture (HVT)$12.80$13.708.67%
M.D.C. Holdings (MDC)$27.35$38.62*56.51%
Pulte Homes (PHM)$33.83$46.3937.60%
Average Gain:+28.24%
S&P 500 (SPY)-16.05%
Source:, * Adjusted for an 11:10 split

Table 3: U.S. listed stocks that pass Graham's tests as of the close of 10/27/02 from
CompanyPrice ($)P/EP/E 5Year LowP/Book5Year EPS Growth (%)Current RatioDebt To Equity1Yr Revenue (M)5Year Dividend Growth (%)
Centex (CTX)46.38 7.0 4.1 1.30 22.88 5.8 2.59 8,021 5.43
Pulte Homes (PHM) 46.17 7.0 3.4 1.15 38.42 2.8 0.79 6,926 8.21
D.R. Horton (DHI) 20.16 7.2 3.6 1.39 32.19 7.0 1.38 6,084 46.45
Woodward Governor Company (WGOV) 36.62 7.3 5.2 1.17 26.99 2.3 0.22 703 12.87
M.D.C. Holdings (MDC) 37.91 7.3 2.6 1.41 39.79 2.7 0.24 2,224 18.90
Standard Pacific (SPF) 25.10 8.0 2.6 1.16 33.04 6.1 0.97 1,633 19.59
Seaboard (SEB) 207.00 8.9 2.2 0.57 9.84 2.2 0.42 1,821 5.70
Universal Forest Products (UFPI) 18.34 9.7 6.7 1.33 12.22 2.1 0.87 1,626 5.80
Haverty Furniture (HVT) 11.75 11.2 5.9 1.40 16.25 2.6 0.58 703 6.26
Watsco, Inc. (WSO) 14.25 14.0 9.8 1.18 5.73 3.6 0.30 1,188 2.25
CompanyPrice ($)P/EP/E 5Year LowP/Book5Year EPS Growth (%)Current RatioDebt To Equity1Yr Revenue (M)5Year Dividend Growth (%)

Additional Resources:

First published in the December 2002 edition of the Canadian MoneySaver magazine.

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