Ben Graham Value Bets

03/28/2014 9:00 am EST

Focus: STOCKS

John Reese

Founder and CEO, Validea.com And Validea Capital Management

John Reese, editor of Validea, analyzes the investment strategies of a "legendary" investor. For his latest Guru Spotlight, he turns to the father of value investing, Benjamin Graham.

Today, many investors look to Warren Buffett for advice about the stock market and economy. But before he became one of the world's richest men and greatest investors, there was someone whose investment advice Buffett himself cherished: Ben Graham.

And Buffett was far from alone. Known as "The Father of Value Investing," Graham inspired a number of famous "sons"—Mario Gabelli, John Neff, and John Templeton—are Graham disciples who went on to their own stock market greatness.

Graham built his reputation—and fortune—by using an extremely conservative, low-risk approach to investing. To him, preserving one's original capital was every bit as important as netting big gains.

In terms of specifics, Graham's "Defensive Investor" approach limited risk in a number of ways, and my Graham-based model lays out several of those methods.

For example, one key criterion is that a firm's current ratio is at least two, showing that the firm is in good financial shape.

Two other criteria the Graham method uses to find low-risk plays: the price/earnings ratio and the price/book ratio. Graham wanted P/E ratios to be no greater than 15 (and, as another signal of his conservative style, he looked not only at trailing 12-month earnings but also at three-year average earnings).

For the price/book ratio, he used a more unusual standard: He believed that the P/E ratio, multiplied by the P/B ratio, should be no greater than 22.

Here are the current holdings of the ten-stock Graham portfolio:

HollyFrontier Corp. (HFC)

National-Oilwell Varco (NOV)

Sears Hometown and Outlet Stores (SHOS)

Coach (COH)

AGCO Corporation (AGCO)

Sasol Limited (SSL)

Big Lots, Inc. (BIG)

The Buckle, Inc. (BKE)

Compania de Minas Buenaventura SAA (BVN)

Chevron Corporation (CVX)

Since I started tracking my Guru Strategies nearly ten years ago, the performance of my Graham-based model has been rather remarkable. Even though the strategy Graham outlined is now more than 60 years old, it just keeps on working.

Through February 25, the ten-stock Graham-based portfolio was up 365.4% since its July 2003 inception, making it one of my best ten-stock performers. That's a 15.6% annualized return in a period in which the S&P 500 (SPX) has gained just 5.9% per year.

The Graham portfolios' long-term results are a great demonstration of how you don't need fancy theories or gimmicks; you just need to focus on good companies whose stocks are selling at good values.

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