Quantifying The Father of Value Investing – Validea’s Guru Investor Blog
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Benjamin Graham (1894-1976) is considered the father of value investing and one of the most influential figures in investment history. His teachings and writings, especially his books Security Analysis (1934) and The Intelligent Investor (1949), laid the foundation for a patient, risk-averse approach to investing that has been followed by many successful investors, most famously Warren Buffett.
Pioneering a disciplined, “defensive” approach focused on financial strength and cheap valuations, Graham achieved an excellent long-term track record. From 1936-1956, his Graham-Newman Corp. posted annualized returns of about 20%, far outpacing the 12.2% average return for the market during that period. And the success of his many protégés, like Buffett, Walter Schloss, and Bill Ruane, is a testament to the enduring wisdom of his philosophy.
Graham’s Life and Career
Graham’s early experiences seem to have played a key role in shaping his famously conservative investment philosophy. Born in London into a once well-off family that fell on hard times, Graham learned at an early age how quickly wealth can disappear. After losing his father at age 9, young Benjamin watched his mother try and fail at several business ventures and lose money in the Panic of 1907.
A star student, Graham got into Columbia and took a job on Wall Street after graduation. He started his own firm, the Graham-Newman Corporation, in 1926. Then the 1929 crash hit, devastating his clients. Graham worked five years without pay to restore his investors’ capital. This experience reinforced his belief in preserving capital and minimizing downside risk. “Though the experience was dreadful, it earned Graham widespread respect for his integrity as a money manager,” Janet Lowe wrote in Value Investing Made Easy. “Once the Graham-Newman Co. recouped its portfolio of 1929-30, Graham never again lost money for his clients.”
Core Tenets of the Graham Philosophy
Graham’s goal was to create a successful, yet low-risk portfolio. To do so, he believed in being an “intelligent investor” focused on the real value of businesses, not short-term speculation. Some key aspects of his approach:
Intrinsic Value: Graham sought to calculate a firm’s intrinsic value based on measurable factors like assets, earnings, and dividends. He then only bought when the stock price was well below that intrinsic value – when it had a large “margin of safety” that would protect him from downturns.
Financial Strength: Graham looked for companies with strong balance sheets, including high current ratios and low debt. He wanted to invest in firms that could withstand varied market environments.
Consistent Profitability: While Graham didn’t emphasize growth, he did look for companies with a history of steady profits. This demonstrated the company’s ability to prosper in good times and persevere in bad.
Cheap Valuations: Graham used strict valuation criteria like low price/earnings and price/book ratios to find stocks selling at a significant discount to their inherent worth. This both increased upside potential and limited downside risk.
Dividends: Graham placed a high emphasis on companies with long histories of paying dividends, another sign of financial strength and stability.
Diversification: Graham recommended owning a diversified basket of stocks that met his criteria to spread risk, targeting at least 10 and as many as 30 holdings.
Long-Term Mindset: For Graham, investing was about consistently applying a sound, rational process over the long-term. He paid little attention to short-term market fluctuations, as long as the businesses he owned remained financially sound.
Validea’s Graham-Inspired Model
Using The Intelligent Investor as the primary source, Validea has built a quantitative investment model that encapsulates Graham’s core philosophy. With a few minor adjustments to account for the modern market, the Validea Graham model looks for stocks with:
- Current ratios above 2.0
- Long-term debt less than net current assets
- 10-year earnings per share growth above 30% with no negative years in the last 5
- Average 3-year P/E ratios below 15
- Price/book ratios below 1.5
- Excluding technology companies
Some Current Graham-Approved Stocks
As of early April 2023, here are five stocks that earn perfect scores from Validea’s Graham model:
- Cal-Maine Foods (CALM): Cal-Maine is the largest producer and distributor of fresh shell eggs in the U.S.
- Commercial Metals (CMC): Commercial Metals manufactures, recycles and markets steel and metal products and related materials.
- Ingles Markets (IMKTA): Ingles Markets operates a regional chain of supermarkets in the southeast U.S.
- Shoe Carnival (SCVL): Shoe Carnival is a family footwear retailer providing customers with a unique shopping experience.
- Standard Motor Products (SMP): Standard Motor Products manufactures and distributes replacement parts for motor vehicles.
Each of these companies has the strong financials, cheap valuations, and consistent operating history that Graham prized. Of course, quantitative models are just a starting point for in-depth research. But Graham’s approach has certainly stood the test of time. By staying disciplined and focusing on value and safety over speculation and excitement, Graham achieved one of the best records in investment history – and helped generations of other investors do the same.
Research Links
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