The Guru Investor Blog
Thoughts, Ideas and Insights from Top Minds in the Investment World
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Fri, 24 May 2013 11:13 AM
The Graham-Based Strategy: 300%+ Returns Since '03
Every other issue of The Validea Hot List newsletter examines in detail one of John Reese's computerized Guru Strategies. This latest issue looks at the Benjamin Graham-inspired strategy, which has averaged annual returns of 15.4% since its July 2003 inception vs. 5.3% for the S&P 500. Below is an excerpt from the newsletter, along with several top-scoring stock ideas from the Graham-based investment strategy.
Taken from the May 24, 2013 issue of The Validea Hot List
Guru Spotlight: Benjamin Graham
Today, many investors look to Warren Buffett for advice about the stock market and the economy. But before he became one of the world’s richest men and greatest investors, there was someone whose investment advice Buffett himself cherished: Benjamin 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, John Templeton, and, most famously, Buffett, are all Graham disciples who went on to their own stock market greatness.
So, just who was Graham? Born in England in 1894 as Benjamin Grossbaum (his family later changed its surname to Graham during World War I, when German names were viewed with suspicion), 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, and two factors from his early years may show why. The first was Graham’s own family’s fall from financial comfort to poverty not long after his father died when he was nine. The second involved his first major business venture, an investment firm he founded with Jerome Newman. Just three years after opening, the stock market crash of 1929 and the Great Depression arrived. Graham’s clients, like just about everyone else, were hit hard, according to Graham biographer Janet Lowe, and Graham worked without compensation for five years until his clients’ fortunes were fully restored.
Having lived through both his own family’s financial troubles and the market crash, it’s no surprise that the strategy Graham laid out in his classic book The Intelligent Investor was a conservative, loss-averse approach. To Graham, an investment wasn’t something that could be turned into quick, easy profits; anything that offers such “easy” rewards also comes with substantial risk, and Graham abhorred risk. True “investment”, he wrote, deals with the future “more as a hazard to be guarded against than as a source of profit through prophecy.”
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 — that is, the ratio of its current assets to its current liabilities — is at least two, showing that the firm is in good financial shape. The approach also targets financially sound firms by requiring that long-term debt not exceed net current assets. 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, to ensure that one-year anomalies didn’t skew the P/E ratio). 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.
My Graham-inspired strategy tends to find bargains across a variety of areas of the market. Here are the current holdings of the 10-stock Graham portfolio:
HollyFrontier Corp. (HFC)
Cheung Kong Holdings Limited (CHEUY)
Alliant TechSystems (ATK)
National-Oilwell Varco (NOV)
NTT DoCoMo, Inc. (DCM)
Bridgepoint Education (BPI)
Chevron Corporation (CVX)
Inter Parfums (IPAR)
Western Digital Corp. (WDC)
Apollo Group (APOL)
Two types of stocks that you won’t find in the Graham portfolio are technology and financial firms. Graham excluded tech stocks from his holdings because they were too risky, and, while they’re not as risky today, I do the same. Financial stocks, meanwhile, aren’t explicitly excluded from my Graham model. But because of the low-debt requirements in this strategy, it’s nearly impossible for a financial firm to garner approval. Since I started tracking my Guru Strategies nearly 10 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 May 20, the 10-stock Graham-based portfolio was up 311.8% since its July 2003 inception, making it my best 10-stock performer. That’s a 15.4% annualized return in a period in which the S&P 500 has gained just 5.3% per year. The model’s strict balance sheet criteria helped it avoid big losers in 2008, as the portfolio lost less than half of what the broader market lost, and it rebounded big in 2009 and 2010, gaining 31.4% in ’09 and 22.6% in ’10. In 2011, it had its worst year, however, falling 19.0% while the broader market was flat. It rebounded nicely, though, gaining 33.8% in 2012 and 22.0% so far this year.
It’s also worth noting that the 20-stock Graham-based portfolio I track has been even better. In fact, it’s the best performer of any of my 10- or 20-stock portfolios, having returned 389.4% since its July 2003 inception — that’s 17.5% per year.
The Graham portfolios’ long-term results are a great demonstration of how successful stock investing doesn’t need to be incredibly complex or cutting-edge. You don’t need fancy theories or gimmicks; you just need to focus on good companies whose stocks are selling at good values. Do that, and you should produce some strong results of your own.
Tagged: Benjamin Graham, John Reese, Validea 
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Fri, 24 May 2013 3:32 AM
Sonders On How The Market Keeps Rising
Charles Schwab Chief Investment Strategist Liz Ann Sonders says that “traditional supports” remain in place to back the stock market’s recent gains, and also notes that some non-traditional supports are also present — for the moment, at least.
“There remain traditional supports for the market’s advance, notably very strong earnings and still-reasonable valuations,” Sonders writes in commentary on Schwab’s web site. “Compared to both the 2000 top and the 2007 top, earnings are notably higher, valuations more reasonable and interest rates (and inflation) much lower.”
But, Sonders says, despite the market’s rise, individual investors have remained lukewarm on equities. The gains, she said, are driven instead by a dwindling of supply (caused by near-record levels of stock buybacks by companies) and increased demand from some non-traditional sources. One is central banks. “Behind the heightened interest in stocks are growing central-bank reserves requiring increased diversification,” she writes. “In US dollar terms, the four largest central banks have expanded their balance sheets to more than $13 trillion, compared to only $3 trillion 10 years ago. Most central banks have had heavy and consistent reliance on fixed-income securities, but with yields low (and falling) in many countries, keeping all reserves in fixed income risks a declining value of reserves.”
In addition, Sonders says the number of bond mutual funds that own or are buying stocks is at its highest point in 18 years. “The trend is easy to understand when considering the quandary many fixed-income investors face,” she writes. “There’s been a bull market in bonds for more than 30 years, and yields, which move in the opposite direction of prices, are near record lows.”
Tagged: Liz Ann Sonders 
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Thu, 23 May 2013 4:55 PM
Herro: EMs Too Pricey
Top fund manager David Herro, who benefited from emerging market stocks in the 2000s, is now finding little opportunity among them. ”It all has to do with price,” Herro tells Bloomberg. He says his fund went big into emerging markets in the late 1990s, but has pared back more and more as prices have gone up. He says emerging equities aren’t “catastrophically overpriced”, but that there are better opportunities now. Herro likes developed-world companies that capitalize on emerging market growth, like Daimler. He says he is most concerned with price and free cash flow when picking stocks, and adds that investors often get too wrapped up in what country a company is based.
Tagged: David Herro 
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Thu, 23 May 2013 4:12 PM
To Buffett, Growth Is Value
In the latest issue of Forbes magazine, Validea CEO John Reese says that good investors — including Warren Buffett — don’t get fooled into playing the “growth vs. value” game.
While people constantly try to pit growth stocks and value stocks against one another, Reese says the distinction is a flawed one. “Just ask Warren Buffett,” he writes. “He doesn’t seem to differentiate much between growth and value. ‘Market commentators and investment managers who glibly refer to ‘growth’ and ‘value’ styles as contrasting approaches to investment are displaying their ignorance, not their sophistication,’ he explained in his 2000 annual letter to Berkshire Hathaway shareholders.”
Buffett, Reese says, sees growth as one component of value, and he points to a couple recent Berkshire buys to show how Buffett takes growth into consideration when assessing value. He also talks about his Buffett-inspired Guru Strategy, which picks stocks using the approach Buffett reportedly used to build his empire. Reese looks at a few of his Buffett-based model’s current favorites, including PetSmart. To read the full article and see the other stocks, click here.
Tagged: John Reese, Validea, Warren Buffett 
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Wed, 22 May 2013 11:24 AM
Dalio: Cash and Bonds "Terrible" Plays Right Now
Hedge fund guru Ray Dalio says cash and bonds are both “terrible” investments right now. Dalio tells CNBC that with interest rates kept artificially low by the Federal Reserve, investors have been reaching for return in other areas, driving asset prices up. He also says “there’s the beginning of a leveraging process” going on. Those factors are good for assets in the near term, Dalio says. “I think that assets will continue to appreciate, but there’ll also be a tightening ahead,” he says.
Tagged: Ray Dalio 
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Wed, 22 May 2013 10:38 AM
Why Value Investing Is More Relevant Than Ever
Value stocks have collectively lagged growth stocks by a decent margin over the past five years, leading many to question whether value approaches still work. In a piece written for Institutional Investor, however, Joseph G. Paul and Kevin Simms of AllianceBernstein say the discipline is alive and well — and more relevant than ever.
Paul and Simms look at some of the behavioral biases that underpin value investing approaches, including loss aversion, trend extrapolation, and short-term focus. All of these factors, they say, have been on display since 2008. “Investor loss aversion was heightened by the severe crash of 2008 and the ensuing volatility,” they say. “An abundance of bad economic and corporate news has made erroneous trend extrapolation even more ubiquitous. And as markets have lurched from crisis to crisis, with recurrent spikes in volatility, investors’ time horizons have become extremely short.”
Over the longer haul, however, these biases “are likely to eventually correct themselves and reward investors who have stuck to their knitting and dared to defy the crowd,” Paul and Simms write. They say, in fact, that many of the recent changes in the market — lower trading costs, technology that makes it easier to buy and sell stocks, and the instantaneous availability of information — “promote emotional reactions by investors”. Because of that, they say they believe “that traditional research-driven behavioral investing makes more sense than ever in the 21st century.”
Tagged: Joseph G. Paul, Kevin Simms 
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Tue, 21 May 2013 10:56 AM
Guru Strategy Ratings: WFC, T-Mobile On The Move
Each week, we take a look at which stocks John Reese’s Validea.com Guru Strategy computer models have newfound interest in, and which they have soured on. Here’s a look at some of the stocks John’s strategies have upgraded or downgraded today.
Tagged: John Reese, Validea 
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Mon, 20 May 2013 11:21 AM
Birinyi On Why The Bull Won't Stop Here
Strategist Laszlo Birinyi sees stocks going higher, backed by good fundamentals and good sentiment conditions. Birinyi tells Bloomberg that many investors are still “fighting the tape”, and that sentiment thus hasn’t gotten too frothy. He says fundamentals are getting better, with key companies within the S&P 500 — like Google — performing well. Birinyi says the bull market is in its fourth phase, and history has shown fourth phases of bulls can involve gains of 40% to 50% for the broader market. He says that investors shouldn’t try to predict minor market pullbacks, saying that it’s impossible to predict 5% pullbacks in the market.
Tagged: Laszlo Birinyi 
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Fri, 17 May 2013 10:16 AM
Finding Growth In A Slow-Growth Economy
Growth has been sluggish in the United States for some time now. But in a recent Seeking Alpha column, Validea CEO John Reese says that doesn’t mean there’s no growth to be had for investors.
“While the broader economy continues its muddle-through advance, many individual companies are putting up some very impressive growth numbers,” Reese writes. “And with so many fearful about the overall economy, a lot of these fast-growing firms’ shares are available for significantly cheaper than they might otherwise be.”
Reese says his Guru Strategies, each of which is based on the approach of a different investing great, have been finding a number of growth plays lately. He looks at five of them, including MWI Veterinary Supply.
Tagged: John Reese, Validea 
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