The Graham And Dodd Method
In 1934, David Dodd and Benjamin Graham (Buffett's teacher) wrote what would later be known as the foundation for value investing. Security Analysis
(In reading the latter section, if you didn't know the book was from 1934, you would think he was describing the dot-com boom and bust of the early 2000s. It's actually scary.)
I digress.
The Lessons
Graham and Dodd came up with a method for valuing stocks, primarily looking for deeply depressed prices. Graham and Dodd were looking for stocks that had a high earnings-to-price ration, a low P/E (based on its history), a high dividend yield, a price below its book and net current asset value.
In addition, they wanted to see total debt less than book value, a current ratio greater than two, earnings growth of at least 7% for the past ten years, and no more than a 5% decline in earnings in more than two of those ten years.
The Result
According to Fort Hays State University, the Graham-Dodd method (used by Graham & Dodd in the Graham-Newman hedge fund) produced an annual return to shareholders of 15.5% from 1945-1956. Not bad—except the S&P 500 returned 18.3% for that same period.
How Dare I!
I'm not knocking Graham. All I'm saying is that Graham himself, shortly before his death in 1976, said:
I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook "Graham & Dodd" was first published; but the situation has changed...
KISS
Keep it simple. As Buffett says,
There seems to be some perverse human characteristic that likes to make easy things difficult...The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective.
Think about that the next time you start to overanalyze a stock. If you have to think too hard about it, it probably isn't worth your money.
Disclaimer
- The above link to Security Analysis is a paid link to Amazon.com. The book is highly technical in nature and very long—not a casual read, but still a great one.
Also Filed Under "How to Think About Investing"
Joe Ponzio's F Wall Street
Submitting Your Comment
Please wait while your comment is submitted. (It may take a moment.) Comments on F Wall Street are moderated which means that your comment will appear only after it has been reviewed by Joe. Comments are typically reviewed and approved (or denied) quickly, except between 11:30PM and 5:00AM (CST) – Joe has to sleep some time!
Joe Ponzio's F Wall Street
Thank You For Participating!
Thank you for participating on F Wall Street. Once your comment has been approved, it will appear here. While waiting, check out some other articles on the blog or click here to return to the article.
| Excel 2007 | | | Excel 2003 |
| (ZIP, 168kb) | (ZIP, 138kb) |
Search F Wall Street
Powered by Google
Subscribe to F Wall Street
E-mail or RSS updates. And it's free!
Articles, by Category
Or visit the archives for articles by date
Thu @ 3:33PM | View comment
MinorityStakes said,
A couple comments regarding BBEP's latest communication with shareholders:* 2009 production just about equaled 2008 production even though capex was...
BreitBurn Energy: Playing the Commodities Crash
Sun @ 11:09AM | View comment
Eric T said,
Instead of inventory turnover, I use the cash conversion cycle, or CCC.It is more accurate for companies that manufacture and...
Understanding the True Profit Margin
Sun @ 5:48AM | View comment
Diversification said,
well it all depends on the correlation between the stocks you have choosen many big mutual funds are having the...
The Dangers Of Overdiversification
Sun @ 4:46AM | View comment
sandesh trivedi said,
Very well explained joe. i believe one must also take into account the nature of the product being manufactured while...
Understanding the True Profit Margin
Sat @ 10:19AM | View comment
Ron said,
Hi Joe,Is there a rule of thumb of percentage of net shares sold by insiders where we should start to...
When To Watch Out For Insider Selling
Sat @ 10:18AM | View comment
jan said,
joe, any thoughts on jackson hewitt? what were the risks that played out in your mind when you decided...
BreitBurn Energy: Playing the Commodities Crash
Joseph
Aug 14th, 2007
3 comments
You talk about Keeping it Simple- but now a days nothing seems to be simple for the casual investor like myself? What 2 or 3 things should I be looking at when determining if I should be investing in a company?
( REPLY | PERMALINK )
Joe Ponzio
Aug 14th, 2007
Joe on twitter
Ponzio Capital
Great businesses steadily increase owner earnings and net worth and can stand on their own two feet without needing additional capital from outside sources (selling stock, assuming debt, etc.)
What should you look for? Start with:
1) Steadily increasing owner earnings;
2) Steadily increasing shareholder equity;
3) Low relative capital expenditures for maintenance of operations.
Find those businesses and you'll be on your way. Hope that helps!
( REPLY | PERMALINK )
Pakorn
Aug 16th, 2007
( REPLY | PERMALINK )
paolo
Oct 11th, 2007
5 comments
Where did you get the 1976 Graham quote? That is fascinating! He is quoted or referred to extensively by investors/journalists, but I've never seen anybody else mention that before. I'm interested in seeing the full context.
Reason being, I've tried a few times to get through Chapter 1 of Security Analysis, but if Graham is "recanting" maybe I should move that further down my reading list.
( REPLY | PERMALINK )
Joe Ponzio
Oct 11th, 2007
Joe on twitter
Ponzio Capital
The full quote:
Interviewer: In selecting the common stock portfolio, do you advise careful study of and selectivity among different issues?
Graham:
In general, no. I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook "Graham and Dodd" was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I'm on the side of the "efficient market" school of thought now generally accepted by the professors.
Hope that helps!(When asked to expand on one of his approaches):
This is similar to the first in its underlying philosophy. It consists of buying groups of stocks at less than their current or intrinsic value as indicated by one or more simple criteria...They consistently show results of 15 per cent or better per annum, or twice the record of the DJIA for this long period. I have every confidence in the threefold merit of this general method based on (a) sound logic, (b) simplicity of application, and (c) an excellent supporting record. At bottom it is a technique by which true investors can exploit the recurrent excessive optimism and excessive apprehension of the speculative public.
( REPLY | PERMALINK )
Jmoney
Mar 19th, 2008
Are you familiar with Fort Hays State University? That is my alma mater and the site you linked to was produced by my former advisor.
I just thought it was interesting. FHSU is a relatively unknown school in Western Kansas.
( REPLY | PERMALINK )
Joe Ponzio
Mar 19th, 2008
Joe on twitter
Ponzio Capital
Beyond the name, I'm not familiar with the school. Google helped me out on that one. ☺
( REPLY | PERMALINK )
Your Name
Mar 13th, 2010