Ben Graham: Lasting Value

10/02/2015 10:00 am EST


John Reese

Founder and CEO, And Validea Capital Management

John Reese, editor of Validea, discusses the time-tested strategy of Benjamin Graham, its enduring influence on many of the market's most successful investors, and several stocks that meet the Graham-based criteria.

Steven Halpern:  Our guest today is John Reese, editor of Validea.  How are you doing today, John?

John Reese:  Doing very well, thank you, Steven.

Steven Halpern:  Now for those not familiar with your excellent ongoing research, you assess stocks based on the strategies of many of the market’s most legendary investors. Today we’re going to focus on Benjamin Graham. Could you share some background on the man that’s considered by many to be the father of value investing?

John Reese:  Sure. Benjamin Graham is the oldest of the gurus that we follow at Validea.  He is considered the founder of the entire field of security analysis and also known—as you mentioned—as the father of value investing.  

He spawned several of history's greatest other investors including Warren Buffett and a slew of others that are more or less well known over time.  

Steven Halpern:  Now you recently wrote a fascinating article on Graham and I was shocked to learn of all of the different investors who are Graham disciples. Could you go into that a little bit?

John Reese:  Sure.  Warren Buffett himself credited this in a speech that he gave at Columbia University, but among some of the original disciples and protégés of Benjamin Graham were Walter Schloss, who has a 16% annualized return over 28 years, Tom Knapp with a 20% return, and Warren Buffett himself.  

It expands even bigger than that. He had a major influence on John Templeton, Mario Gabelli, John Neff, Charles Munger himself, and quite a few others.  

One that has touched me personally, a distant relative of mine Conrad Taft was also a protégé of Benjamin Graham.  He actually had a great deal of influence on my father, who also therefore when I was young had influenced my style of investing.

Steven Halpern:  Now when you assess stocks based on the Benjamin Graham strategy, what factors do you reveal, and I understand there are many, but perhaps you could just highlight some of the most important.  

John Reese:  Certainly. In terms of specifics, Graham’s Defensive Investor Strategy looked to limit risk and he did that first of all by looking at the current asset ratio of a firm.  

He wanted to see that it was at least 2.0.  The current asset ratio compares the current assets—including cash of a firm—compared to its current liability.  

A second, other criteria and he wants to find low risk by looking for low price-to-earnings ratios, in this case meaning less than 15, and low price-to-book ratios.  

You needed a very novel way of looking at that.  He wanted to see that the price-to-book ratio multiplied by the price:earnings ratio itself was less than 22.  

Those are some of the key criteria that Benjamin Graham used as well as certain limitations in terms of the debt of the firm compared to the cash that it has on hand.  

Steven Halpern:  Despite all of the changes that have occurred in Wall Street over the decades, are you suggesting that the Graham model that was developed back then still works effectively? And for selecting Graham-based stocks for your model portfolio, how has the performance of that done?


John Reese:  Yes, I am suggesting that it’s still working, even after 60 years. Just as an example, for performance in the ten years that we’ve been tracking my model based upon Graham’s Defensive Investor Strategy, it’s had a 9.4% annualized return at a time when the S&P 500 (SPX) gained just 5.7% per year.

And it’s strict balance sheet requirements helped it avoid big losers in 2008 as the portfolio loss less than half of what the broader market lost.  Furthermore, it rebounded big in 2009 and ’10.  Yes it still continues working on a long-term basis even today, even after 60 years.

Steven Halpern:  That’s incredible. Perhaps to help explain how this model works you could walk us through a few Graham-like picks that are based on this approach.

John Reese:  Sure. One of the current picks would be Zumiez (ZUMZ), which is a multi-channel specialty retailer of apparel, footwear, basically, they have cool apparel and accessories, including, like, handbags and they sell through 500 different retail stores.  

Basically, the price:earnings ratio and price-to-book ratio are extremely low on those so it’s a value investing despite the fact that it has both high growth (which is unusual, that’s just an extra characteristic) and it has no long-term debt.

Steven Halpern: Is there any other stocks that would stand out among the Graham portfolio?

John Reese:  Yes. The second one, Chart Industries (GTLS), which is a manufacturer of engineered equipment for industrial, gas and energy, and biomedicals, like cryogenic equipment.  It also basically is a value invest and play with a low price to earnings and a low price-to-book and a high current ratio.  

A third one is Liquidity Services (LQDT), which is a very interesting firm because they’re an auction marketplace for surplus and salvage assets.  They run like 500 different marketplaces for different kinds of online auctions that appeal to more professional firms.

They have grown to about three-quarters of $1 billion in terms of size, in terms of sales, yet, nevertheless, they’re unappreciated, low price-to-earnings and low price-to-book ratio and very nice growth ratio are included in that.  

Steven Halpern:  It’s always fascinating to hear your thoughts.  Thank you so much for taking the time today.

John Reese:  Nice talking to you, Steven.

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