WHAT ARE WE LOOKING FOR?
Yesterday we took a final look at a portfolio we created in September, 2008, based on the strategy of the late Benjamin Graham. The portfolio handily outperformed the S&P 500, so today we'll set up a new portfolio and see if it meets with similar success.
THE GRAHAM APPROACH
Known as the father of value investing, Mr. Graham continues to have enormous influence decades after his death in 1976. His strategy reflects the difficult financial circumstances he faced, both as a young man when he lost his father and later during the Great Depression.
"Graham used a conservative, risk-averse approach that focused as much on preserving capital as it did on producing big gains," Validea.com explains. "Trendy, hot stocks didn't garner his attention; he was concerned with companies' balance sheets and their fundamentals."
Central to his approach was the idea of "margin of safety." His goal was to buy stocks at a discount to their "intrinsic" value, so that the risk of loss was limited.
Mr. Graham's most famous disciple is Warren Buffett. Reflecting the important role Mr. Graham played in his life, Mr. Buffett gave his eldest son the middle name Graham.
We used the Graham Value Investor screen developed by Validea.com. The screen looks for companies with the following attributes:
- Current assets must be at least double current liabilities, and long-term debt must not exceed net current assets (current assets minus current liabilities);
- Earnings per share must have grown by at least 30 per cent over the past 10 years (we're referring here to total earnings growth, not an annual average);
- The company must not have posted a loss in any of the past five years;
- The current price/earnings ratio and the P/E based on average earnings of the past three years must be 15 or less;
- The price-to-book ratio multiplied by the P/E must be less than 22.
We set up a hypothetical portfolio by "investing" $10,000 (U.S.) in each stock. We'll check back every few months to see how the portfolio is performing.
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