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When I say the name Dexys Midnight Runners, I’m sure most of you will not have a clue who or what I’m talking about. However, if I mention the song “Come on Eileen”, those who are familiar with 80s music will know exactly what I’m talking about.
Unfortunately, one of the best hits ever produced remained exactly that for one-hit wonder Dexys Midnight Runners – an achievement never to be repeated.
Much like this British pop group, there have been many investment managers with single hits of their own, which, unfortunately, they too could never replicate. If I were to ask investors to name someone in the investment world who could produce hit after hit, the first name that would jump to mind would surely be Warren Buffett.
Today, however, I would like to introduce you to the legendary Benjamin Graham, Buffett’s mentor (by Buffett’s own admission).
Graham, also known as the Father of Value Investing and author of the famous The Intelligent Investor, published in 1949, delivered a return of 20% per year to his investors between 1936 and 1956, compared to the US stock market’s 12.2% per year. Had he only managed this once or twice, we could have perhaps attributed it to sheer luck, but he did it frequently and over several decades.
This is all very well, but this was a long time ago and surely things have changed since then? Well, not quite. Graham followed strict principles and invested in strict accordance to them. He identified shares which, according to him, were completely undervalued and invested exclusively in those shares.
His simple valuation method to identify these value shares meant that they:
1. had to have a price-to-earnings ratio (P/E) of less than 10; and
2. had to be those of companies whose debt-to-equity ratio (i.e. the amount of debt versus equity that is used to finance the company’s assets) was below 50% (the lower this ratio, the less debt is used).
He would then buy these shares and keep them for a period of two years, or until the price increased by 50% after purchasing them. Before you rush off to buy these types of shares individually, however, it’s important to note that this model also requires you to be invested in a minimum of 30 shares at a time.
Tobias Carlisle and Dr Wesley Gray went about testing Graham’s principles on data ranging from 1976 (after Graham’s principles were published in the Financial Analyst Journal) to 2011.
As can be seen in the graph, it is clear that even in this modern era of technology and access to information Graham’s strategy would still have outperformed the S&P500 – an index that gauges how US equities perform – since 1976.
- African Rainbow Minerals
- Assore
- Consolidated Infrastructure
- Exxaro
- Harmony
- Kumba
- Net1 UEPS Technologies
- Pan African Resources
What’s interesting about these stocks is that six of these eight shares currently find themselves in the highly underperforming resource sector.
Although the average 12-month historical P/E on these shares is currently trading at just above 7 times (with all the recent controversy surrounding it, I decided to exclude Net1 – there could be a good reason for its low rating), the earnings on the seven remaining shares would have delivered around 7% better returns compared to the FTSE/JSE All Share Index.
According to Graham’s models, however, they remain highly undervalued. First, we should ask what the reasons are for their undervalued status and second, whether an investment opportunity still exists. Remember that this strategy is aimed at attempting to identify companies that are undervalued.
None of these companies experience overnight corrections, so investors should be willing to stomach negative fluctuations over the short term. Invest selectively, keep your emotions out of your financial affairs and remember that shares are a long-term investment, not an overnight success.
This article originally appeared in the 1 June edition of finweek. Buy and download the magazine here.
