Five Graham Stocks For 2016

Some people think they have to take a great deal of risk to make a fortune in the stock market. But being cautious can also be profitable. It's something I've demonstrated over the last 15 years using Benjamin Graham's defensive approach.

Longtime readers will know that my list of Graham stocks got its start in Canadian MoneySaver shortly after the turn of the century and the approach has performed very well since then. If you had purchased an equal dollar amount of each stock in the first year and replaced them with the new crop of stocks each year thereafter, your portfolio would be up a whopping 898% (17% annualized) over the full period. On the other hand, index investors who bought and held the S&P 500 exchange traded fund (NYSE:SPY) gained 86% (4% annualized) over the same time frame.

It's important to know that the Graham stocks haven't outperformed each and every year. For instance, over the last year they advanced 2% and trailed the market which climbed 3%.

You can explore the full performance record in the accompanying table. The returns figures are provided in U.S. dollar terms, reflect periods between data collection, and include dividends that are reinvested each year when the new stocks are selected.

Mr. Graham's original method for defensive investors is described in his book The Intelligent Investor, which should be on every investor's bookshelf. While the original is a little dated, a new edition (ISBN 0060555661) was published in 2003 with more modern commentary from veteran columnist Jason Zweig. Serious Graham buffs should also invest in a copy of the sixth edition of Security Analysis (ISBN 0071592539), which includes commentary from some of today’s most famous value investors. However, the second book can be daunting for both new and old investors alike.

Mr. Graham’s original rules for defensive investors set a very high bar for stocks to pass. Indeed, no North American stock was able to jump over the bar for most of the last two decades. That's why my version employs a slightly more lenient approach. The main criteria that I use are summarized in the accompanying table.

For instance, I differ with Mr. Graham when it comes to dividends. He originally demanded a twenty-year record of uninterrupted dividend payments whereas I require only some dividend growth over the last five years.

Even with the slightly more relaxed requirements, very few U.S. stocks usually pass the test. At market lows, such as those seen in the spring of 2009, there might be dozens of defensive stocks. But in more normal times less than ten companies make the grade. This time around only five passed the test and they're highlighted in the accompanying table.

It is important to be aware that a well-diversified portfolio should hold more than ten stocks and in most cases many more. Holding a very concentrated portfolio is itself a source of risk. After all, a few individual disasters can really hurt in such cases. That's why it's best to add the defensive stocks to an already reasonably diversified portfolio.

As always, before buying each stock it is important to examine it in great detail. Dig through the numbers and consider the less tangible aspects of each company as well. Get up to speed by reading news stories about the company along with its press releases and regulatory filings.

While my take on Graham’s defensive method has avoided serious trouble so far, it can’t be expected to outperform all of the time. After all, despite its excellent long-term track record, it has trailed the market in six of the last fifteen years and it lost money twice.

Before diving in, take time to become comfortable with the method and value investing more generally. I'd also suggest starting off in a small way with a modest amount of capital because sticking with value stocks through thick and thin might be harder than you expect. But it is a method that defensive investors should consider.

Norman Rothery, PhD, CFA, Founder of StingyInvestor.com, Toronto, ON (416) 243-9580, rothery@stingyinvestor.com, www.stingyinvestor.com