Benjamin Graham’s Simple Way to Select Bargain Stocks

In 1976 Benjamin Graham did an interview with Medical Economics titled The Simplest Way to Select Bargain Stocks. Within the article, Graham described his new investment formula. Graham back-tested the method from 1926-1976 and concluded that such a strategy would have earned 15% or more per year plus dividends. 

Rules

1. The maximum P/E you should pay for a stock is the inverse of 2 times the current AAA corporate bond yield. To get this divide 100 by double the AAA corporate bond. For example, if the AAA corporate bond yield is 6%. Divide 100 by 12 to get our target P/E of 8.33 or 8.  You can find the AAA corporate bond yield on sites such as YCHARTS.
2. Never buy a stock with a P/E greater than 10
3. A company should own at least twice what it owes. This means debt to equity should be less than 50%.
4. Construct a portfolio of at least 30 stocks.
5. Sell once the stock appreciates 50%
6. Hold each stock for at least two years. If it hasn’t appreciated 50%, sell it!

Quotes from the article

On selecting a P/E

“Just double the bond yield and divide the result into 100. Right now the average current yield of AAA bonds is something over 7 per cent. Doubling that you get 14, and 14 goes into 100 roughly seven times. So in building a portfolio using my system, the top price you should be willing to pay for a stock today is seven times earnings. If a stock’s P-E is higher than seven, you wouldn’t include it.” –  Benjamin Graham

“In my opinion, you should never buy a stock with a P-E ratio over 10 no matter how low bond yields get.” – Benjamin Graham

On Price to Book Value

“I favor this simple rule: A company should own at least twice what It owes. An easy way to check on that is to look at the ratio of stockholders’ equity to total assets; if the ratio is at least 50 per cent, the company’s financial condition can be considered sound”. – Benjamin Graham

On the size of your portfolio

“A portfolio of 30 would probably be an ideal minimum”. – Benjamin Graham

On target return

“An objective of 50 per cent of cost should give good results”. – Benjamin Graham

On holding period

If a stock hasn’t met your objective by the end of the second calendar year from the time of purchase, sell it regardless of price”. – Benjamin Graham

Resources

Read the article here: The Simplest Way to Select Bargain Stocks

Moody’s Seasoned Aaa Corporate Bond Yield