Even in a market slump, Ben Graham would win

WHAT ARE WE LOOKING FOR?

This week's columns featuring the Nasdaq Guru Screener tool (nasdaq.com/reference/guru.stm) started reader Dave Edwards pondering: What U.S. stocks would the godfather of gurus, the legendary Benjamin Graham, look kindly upon in this current unsightly market environment?

Well, Dave, ask and ye shall receive. As luck would have it, the Nasdaq Guru Screener does, indeed, have a screen to test the theories of Mr. Graham, the father of value investing. The Value Investor screen was developed five years ago by investment newsletter website Validea.com, and forms the basis of one of the 11 guru-strategy model portfolios Validea tracks.

In fact, the 20-stock Graham Value Investor portfolio has been Validea's top performer since inception five years ago, with returns of 147 per cent - compared with a mere 24 per cent for the S&P 500.

BEN GRAHAM - VALUE GURU

Mr. Graham, who died more than three decades ago, was an early stock analysis trailblazer whose theories have withstood the test of time. Two of his books - Security Analysis (1934) and The Intelligent Investor (1949) - are considered among the most influential investing books of all time. Among his many disciples is investing legend Warren Buffett, who studied under Mr. Graham at Columbia University.

Mr. Graham's basic approach is based on ignoring the often nonsensical moods of the market and focusing on stocks that simply look like bargains relative to their intrinsic value. He favoured large, conservatively financed companies with a long history of uninterrupted dividend payments, and stuck to stocks with relatively low price-to-earnings multiples. His is a long-term, buy-and-hold strategy.

The Graham Value Investor screen will only consider stocks with annual sales above $340-million (U.S.). Current assets must be at least double their current liabilities, and long-term debt cannot exceed net current assets (current assets minus current liabilities). Companies must show per-share earnings growth of at least 30 per cent over the past 10 years, and earnings per share must not have been negative in any of the past five years.

P/E over the past 12 months and the past three years must be no more than 15. In addition, in multiplying P/E by price-to-book, the product must be less than 22.

THE RESULTS

A look at Validea's 20-stock Graham Value Investor model portfolio this year suggests the value approach has been a clear winner in the current U.S. equity slump. The portfolio has posted year-to-date returns of 4 per cent - the only one of Validea's guru portfolios to show positive returns for 2008. The S&P 500, meanwhile, has shed 15 per cent.

The top U.S. stock generated by the Graham screen right now is teen-apparel giant American Eagle Outfitters Inc., whose stock has tumbled 50 per cent over the past 12 months amid a bearish retail market and the recent surprise resignation of its president. The company has no long-term debt, a P/E of just 8.6 based on average earnings over the past three years, and earnings growth of 530 per cent over the past 10 years.

The list is littered with other clothiers, including Men's Wearhouse Inc., G-III Apparel Group Ltd. and Columbia Sportswear Co.

Nasdaq Guru Screener - Benjamin Graham - Value Investor

SOURCE: WWW.NASDAQ.COM