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Benjamin Graham’s 10 Rules – Still Valid Today?

Tan KW
Publish date: Sat, 26 Jan 2013, 08:24 PM
Tan KW
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Much has been made of Benjamin Graham’s so-called “10 Rules” for selecting stocks. In his later years, having started to focus more on earnings and dividends than assets, Ben condensed his six decades of investing experience into ten apparently straightforward rules in order to help the intelligent investor select value stocks. The ten rules produced market-beating returns for five of the six decades that Ben tested it on. Later, limited, testing by Henry R. Oppenheimer from 1974 to 1981 showed that selecting stocks based on two or three of the 10 rules would have brought average annual returns of at least 26 percent. It is interesting to note that Oppenheimer used only 2 or 3 criteria, but not surprising as the rules are extremely onerous and cannot result in a significant number of picks. Let’s review the ten rules here:

  1. An earnings-to-price yield of twice the triple-A bond yield. The earnings yield is the reciprocal of the price earnings ratio.
  2. A price/earnings ratio down to four-tenths of the highest average P/E ratio the stock reached in the most recent five years. (Average P/E ratio is the average stock price for a year divided by the earnings for that year.)
  3. A dividend yield of two-thirds of the triple-A bond yield.
  4. A stock price down to two-thirds of tangible book value per share.
  5. A stock price down to two-thirds of net current asset value — current assets less total debt.
  6. Total debt less than tangible book value.
  7. Current ratio (current assets divided by current liabilities) of two or more.
  8. Total debt equal or less than twice the net quick liquidation value as defined in No. 5.
  9. Earnings growth over the most recent ten years of seven percent compounded—a doubling of earnings in a ten-year period.
  10. Stability of growth in earnings—defined as no more than two declines of five percent or more in year-end earnings over the most recent ten years.

At least one of these rules is probably not significant today. For example: the requirement of “A dividend yield of two-thirds of the triple-A bond yield”; this may have been relevant in Graham’s day but nowadays it is not as common for stocks to pay dividends and bond yields are frequently out of tune with stock market returns, that is to say the relationship between bond yields and dividend yields has likely been inexorably altered over the years.

Earnings growth, and Stability of Earnings are certainly to be considered, as is the Current Ratio. These are easy enough to determine. (Although not currently on our screens, these are items we are planning to add in the future.) Price below two-thirds of NCAV is found on our screens. Price down to two-thirds of tangible book is probably overkill but can be determined, as can Total debt vs tangible book and NCAV, although I prefer to just use the Debt to Equity Ratio.

It’s interesting to note that Graham worked with an Aeronautical Engineer named James Rea on screening these types of stocks. They turned up very few, even back then. Soon after Graham died in 1976, Rea and his son (James Jr.) started a mutual fund – American Diversified Global Value – alas, it didn’t do well at all. Who knows if it was the rules, or the management that was to blame?

Discussions
2 people like this. Showing 13 of 13 comments

kcchongnz

Hey Ah Ben was the most famous investor at his time. His principles are invaluable, even for the present time. But ah I haven't read from any comments in i3investors using his principles, have you? Why not? After all this is a "i3investors" website.

2013-01-27 12:36

KowChye

my humble opinion. Ben is just an ordinary person like all of us, not god. Hence, his rules are for us as guidelines. Not "RULES" that investors MUST follow or adhere. If i'm right, I think they are many out there not agreeable to one or all 10 rules of Ben.

2013-01-27 13:49

alexlulu

kcloh. if i m not mistaken, buffet use graham rules and find that cannot make money wor. hahaha. so he invented his own rules.
in bolehland. only 1 rule is applicable. the Bursuk rule.

2013-01-27 14:25

KC Loh

yeah, Buffett made changes when he met P Fisher and C Munger. in all fairness to Graham, he shaped his rules in the Post-Great Depression era. So a lot of counters were available to his criteria when he set them out!

2013-01-27 14:36

alexlulu

great! my memory is still intact.

2013-01-27 14:41

kcchongnz

How well do Ben Graham’s 10 rules work when it comes picking stocks?

Henry Oppenheimer: studied the portfolios obtained from these screens from 1974 to 1981 and concluded that you could have made an annual return well in excess of the market. Academics have tested individual screens – low PE ratios and high dividend yields to name two – in recent years and have found that they indeed yield portfolios that deliver higher returns. Mark Hulbert, who evaluates the performance
of investment newsletters, found newsletters than espoused to follow Graham did much better than other newsletters.
The only jarring note is that an attempt to use the 10 rules by a mutual fund that would deliver high returns did fail. In the 1970s, an investor name James Rea was convinced enough of the value of these screens that he founded a fund called the Rea-Graham fund, which would invest in stocks based upon the Graham screens. While it had some initial successes, the fund floundered during the 1980s and early 1990s and was ranked in the bottom quartile for performance.
The best support for Graham’s views on value investing don’t come from
academic studies or the Rea-Graham fund but from the success of many of his students at Columbia. While they chose diverse paths, many of them ended up managing money and posting records of extraordinary success.

The above study is quoted from an academic study by Prof Aswath Damodaran of Stern School of Business, New Yoke University.

2013-01-27 14:52

KowChye

wow

2013-01-29 06:44

kclee

i think i will compute an Excel that sum all this 10 rules, maybe 8 since there are some not applicable to us :) after that... i make my screening job easier...

who wan the excel can find me.

2013-06-22 11:32

Alvian

do u mind to send the excel to me? alvianlim@outlook.com

2013-06-22 17:52

paulwongtp

me too pls pls pls paulwongtp73@yahoo.com thgank you

2013-06-22 18:00

Stephen Lee

Please send me the excel format. lee68@streamyx.com. Thank you.

2013-06-25 06:26

jester

I would like the excel sheet as well please. Thank you.
wanazwan.investment@gmail.com

2013-06-25 07:06

Esque

pls send to stormquest2000@yahoo.com. Appreciate it & TQ.

2013-06-25 08:03

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