Profiting from Ben Graham's least known deep value formula

Friday, Oct 12 2012 by
Profiting from Ben Grahams least known deep value formula

It may have skipped most people's attention, but stock markets are looking cheap. Notable hedge fund manager Joel Greenblatt was this week quoted as saying that the market has only been cheaper 13% of the time over the last 23 years. Historically at such extremes of valuation the average 12 month upside in stocks has been 17%, and over 2 years well over 30%. Given such statistics it's quite remarkable that the investing public is still throwing money at the ill perceived safety of cash and low yielding bonds. Sure, there's always risk in the stock market, but right now there may be more risks to the upside than the downside. Perhaps investors ought to be looking for ways to play stocks that offer great return possibilities while minimising business risk. It turns out there's a deep value formula that promises to do exactly that, concocted by the bargain master himself - Benjamin Graham.

Graham, for those that don't know, was Warren Buffett's tutor and one of the greatest value investors of all time. We've covered some of the mechanical ways which Graham used to find bargain stocks before in great detail, but alas some of his most famous bargain hunting techniques (such as the esoteric sounding net-net and ncav strategies) can be unsuitable for risk averse investors. The main critique is that these lists tend to be populated with a lot of small microcap stocks that many investors find those too small, too illiquid, too risky and too hard to trade.

Ben Graham's Last Will - a money making formula

But, towards the end of his life, Graham developed a much more flexible checklist based formula that allows investors to build portfolios of deep value stocks large or small. We have previously written about this ten point checklist that he developed with aeronautical engineer, James Rea, shortly before he died. It's become known as "Graham's Last Will" and was the result of 50 years of backtests to highlight the top ten best performing stock selection criteria.

The ten checks were split in two groups of five, the first five aiming to highlight 'cheap' stocks with strong return possibilities (using low PE, high yields, good asset backing etc), with the second five aiming to find 'low risk' stocks (not much debt, consistent profitability, good liquidity etc). A company gains points for passing each of the…

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5 Comments on this Article show/hide all

UK Value Investor 13th Oct '12 1 of 5

I haven't seen that one before, and I'm surprised by how close it is to what I do, although the details are all different.

Basically he looks at:

  • high earnings yield
  • high dividend yield
  • financial strength through good working capital liquidity and low levels of interest bearing debt
  • good long-term growth
  • consistent long-term growth

That pretty much ticks all my boxes for a sensible approach to investing in businesses. Ben Graham does it again...

Blog: UK Value Investor
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Isaac 13th Oct '12 2 of 5


Is it possible to get an insight in your portfolio please?

I think you write interesting articles, books and have a good screening tool behind you. And I think you have been in the Investing scene for a while.

I would be interested to learn more about your portfolio performance as well as the main strategies you personally use and how that has evolved if you are willing to share?

thank you

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thebuffoon 14th Oct '12 3 of 5

In reply to UK Value Investor, post #1

I haven't seen that one before, and I'm surprised by how close it is to what I do, although the details are all different. ......pretty much ticks all my boxes for a sensible approach to investing in businesses. Ben Graham does it again...

There's nothing new; but it's good to see it being aired for another generation.

If you haven't already,  I really would encourage you to read the Intelligent Investor.

Of course, having gone through the depression, with people going bankrupt, and some eschewing the elevator for a faster route down to the ground floor, the security of investment capital was most certainly at the forefront of everyones mind.

There were far more companies satisfying his original criteria than there are now.  As we all know, we really make our money by buying judiciously. It's a lot harder now.




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Edward Croft 14th Oct '12 4 of 5

This chart is a bit old, but it shows the % of companies over time passing both 2.5 of the 'return' criteria and 2.5 of the 'risk' criteria in the Graham formula across different equity markets of the world. Societe General have used this as a key indicator of market value in recent years. It's clear that when more than 10% of stocks are qualifying for this screen there's often a buying opportunity.  It's certainly highlighted the bottoms during previous market crises.  What is interesting though about the scenario today is that bond rates are being held suspiciously low by coordinated central bank policies.  As 2 of the criteria above depend on AAA bond yield comparisons the number of stocks qualifying for this screen today may be inflated somewhat.  Nonetheless we can clearly see that there's a lot of value in the stock market by this measure.  

Blog: Follow @edcroft on Twitter
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tomomo 28th Nov '14 5 of 5

In reply to Edward Croft, post #4

Ed I'm struggling to find the Soc Gen paper you refer to here and in the recent Interactive Investor article -- is it available online, and do you have reference? Thanks.

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About Edward Croft

Edward Croft

CEO at Stockopedia where I weave code, prose and investing strategies to help investors beat the stock markets. I've a background in the City and asset management but now am more interested in building great stock selection tools for the use of investors online.   Traditionally investors online have had very poor access to the best statistics, analytics and strategies for the stock market and our aim is to set that straight.  High Quality fundamental information has been prohibitively expensive in the past and often annoyingly dull. People these days don't just want to know the PE Ratio and look at a balance sheet. They expect a layer of interpretation over data, signal from noise and the ability to know at a glance whether a stock is worth investigating or not. All this is possible using great design and the insights gleaned from quantitative research.  Stockopedia is where we try to make it happen ! more »


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