A Graham style deep value stock portfolio

Benjamin Graham is considered as the dean of value investing. Warren buffet was graham’s student and considers him as his mentor. Buffett’s followed graham’s approach to value investing in the early part of his career. However later, he expanded on graham’s approach and started focussing on the quality of the business too.

Graham’s approach is basically picking stocks which are statistically cheap. What that means is that the stock is cheap based on various quantitative measures such as mcap being less than Net current assets, or the stock is selling for less than cash on books. The disadvantage of this approach is that you may end up buying some complete dogs which are cheap for a reason. The underlying business would be going downhill and so the value is just an illusion.

Graham understood this and he circumvented it by diversifying. So the key point in building a portfolio of cheap graham style stocks is to diversify the holding. It makes sense to hold 15-20 stocks at a time and to keep selling the stocks when they reach 80-90% of intrinsic value and to replace them with other cheap issues.

With the current drop, I can see more of such opportunities coming up. The last time such an opportunity was come in 2002-2003 time frame.

The initial filter criteria I am using is as follows

Mcap less than 500 crs

Debt / equity ratio less than 0.5

No loss in the preceeding 5-6 years

PE less than 7

ROE atleast 8-10%

The key point, and I repeat, is to hold a large portfolio of these stocks via diversification. Some will turn out to be clunkers, but on an aggregate the portfolio should do well.

Now you may have a valid counterpoint – why buy this stuff when there are good companies getting cheap by the day. That is true ..but if like me you also take a long time to analyse each company, then the above mechanical approach is a quick way to assemble a decent portfolio. If you have the cash and the nerve (I could use a stronger word here :) ) to invest when everyone is pessimistic, then the mechanical graham style of investing can be used to quickly assemble a decent portfolio while the opportunity lasts.