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.
- 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.
- Never buy a stock with a P/E greater than 10
- A company should own at least twice what it owes. This means debt to equity should be less than 50%.
- Construct a portfolio of at least 30 stocks.
- Sell once the stock appreciates 50%
- 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
Read the article here: The Simplest Way to Select Bargain Stocks