Empirical Finance just released a detailed research study that backtested a simple Ben Graham strategy for investing in stocks.
The backtest is based on a 1976 article in Medical Economics magazine, where Graham was interviewed and provided some tips on stock selection.
From the article,
“Graham believes that a doctor handling his own investments should be able to utilize those same principles to achieve an average return of 15 percent a year or better”
According to Graham, investors should look for two defining characteristics when picking stocks:
- P/E ratio of 7 or less
- Shareholder Equity ratio of > .50
Graham also goes on to recommend a portfolio of roughly 30 stocks and a holding period of two to three years.
Empirical Finance has done an amazing job of running the study based on these criteria. Here is the explanation:
“We decided to keep it simple and backtest the low P/E (<10), shareholder equity > .5 strategy from 1965–2010. We also backtested the results in accordance with the “trading rules” alluded to by Graham: stocks entering the portfolio are held for 2 years, or if they appreciate >50%. For robustness, we tested a variety of P/E and shareholder equity combinations–all results are very similar.”
It turns out that Graham was spot on with his return estimates:
Both the small and mid-cap backtests eclipsed the 15% CAGR metric for the study period.
It looks like the large-cap portfolio did not fare as well.
The study is great confirmation that Graham’s methods work, especially for the smaller stocks that are the focus of this blog.
And probably proof that many investors badly over-complicate their stock picking strategies – myself included!