Graham's Strategy Still Producing Excellent Returns

In his latest “Number Cruncher” column for Canada’s Globe and Mail, John Heinzl takes a look at Validea’s Benjamin Graham-inspired stock-picking model, which has continued to produce stellar results some 60-plus years after Graham detailed it in his classic book, The Intelligent Investor.

“Graham used a conservative, risk-averse approach that focused as much on preserving capital as it did on producing big gains,” Heinzl writes, quoting “Trendy, hot stocks didn’t garner his attention; he was concerned with companies’ balance sheets and their fundamentals.” Heinzl notes that the concept of ‘margin of safety’ was central to Graham’s approach. ”His goal was to buy stocks at a discount to their intrinsic value so that the risk of loss was limited,” he writes.

Globe and Mail formed a portfolio of stocks using Validea’s Graham-inspired criteria, and since its April 13, 2010 inception, the portfolio is up 14.8% vs. 8.2% for the S&P 500 (through June 21). That performance is an extension of the strong performance of Validea’s Graham-based portfolio, which has returned 189.5%, or 14.3% annualized, since its July 2003 inception. Over the same period, the S&P has returned just 28.3%, or 3.2% per year.

The Graham-based model focuses on a firm’s balance sheet and its share valuations, looking for conservatively financed companies with bargain-priced shares. Among its criteria:

  • The current ratio (current assets/current liabilities) must be 2.0 or greater;
  • Long-term debt cannot exceed net current assets;
  • Neither the price/earnings ratio using trailing 12-month earnings nor the P/E using average three-year earnings can be over 15;
  • The higher of the two P/Es multiplied by the price/book ratio cannot be over 22