How Graham-Inspired Investing Still Works Today

The real-money Inflation-Protected Income Growth portfolio operates based on three key investing principles inspired by Benjamin Graham: dividends, valuation, and diversification. Graham, the father of the value investing strategy and the man who taught investing to Warren Buffett, designed his strategy around those timeless investing principles, which still work well today.

Since last week's update, the iPIG portfolio gained a bit more than $250 in value. In so doing, it showcased how all three factors act together to drive risk-adjusted returns.

Putting Graham to work
Dividends: Medical device titan Becton, Dickinson & Company (NYSE: BDX  ) paid its quarterly dividend of $0.495 per share on Friday, adding $8.91 to the iPIG portfolio's coffers. That was the company's third dividend at that rate, with one more anticipated before its board of directors reviews its payment for a potential increase.

Dividends play a foundational part in the iPIG portfolio, which looks to generate an income stream that increases at least as fast as inflation. The portfolio was created in December 2012 with $30,000. No additional capital has been added, but thanks to dividends, the portfolio has invested a touch more than $30,094 in its holdings and still has a bit above $254 in cash on hand.

Valuation: On Tuesday, pharmacy retailer and iPIG pick Walgreen (NYSE: WAG  ) reported earnings numbers that failed to live up to Wall Street's expectations. Predictably, the company's shares dropped on the news. Still, the iPIG portfolio is sitting on a nearly 18% gain since those shares were purchased in January. The reason? When selected, Walgreen traded at something of a discount to its fair value estimate.

Graham made the case that companies trading below their fair value estimates had what he called a margin of safety priced into their shares. With a margin of safety, companies can slip up by a bit and still potentially be worth more than an investor paid for them. There are no guarantees, of course, but looking for Graham's margin of safety can tilt the odds more toward your favor.

Diversification: While diversification in and of itself won't enhance an investor's expected returns, it can protect a portfolio from the failure of any one holding within it. The iPIG portfolio was built with an eye toward diversification, as it was designed to own around 20 positions across a variety of industries.

Thanks to the market's moves since the iPIG's inception, the portfolio's value is up about 14%. Thanks to diversification, the portfolio could lose the entire value of its two top holdings, electric generator NV Energy (NYSE: NVE  ) and toy maker Hasbro (NASDAQ: HAS  ) , and still be worth more than when it started.  

Of course, neither company is expected to go out of business anytime soon. Indeed, NV Energy is on track to be bought out by Berkshire Hathaway (NYSE: BRK-B  ) for a substantial premium to the iPIG portfolio's cost. And while Hasbro has reported mixed results recently, it is still expected to grow its earnings over the next several years.

Diversification didn't give the portfolio the 14% improvement in value it has seen since inception. It is, however, providing an important sleep-at-night benefit that comes from knowing that the potential failure of any one pick won't translate into a certain failure for the overall portfolio.

Graham's strategies get the job done
Put together all three aspects of this Graham-inspired strategy, and the result is something that looks like the iPIG portfolio. That portfolio finished last week looking like this:

Company Name

Purchase Date

Number of Shares

Total Investment (including commissions)

Value as of June 28, 2013

United Technologies (NYSE: UTX  )

12/10/2012

18

$1,464.82

$1,672.92

Teva Pharmaceutical (NYSE: TEVA  )

12/12/2012

38

$1,519.40

$1,489.60

J.M. Smucker (NYSE: SJM  )

12/13/2012

17

$1,483.45

$1,753.55

Genuine Parts (NYSE: GPC  )

12/21/2012

23

$1,476.47

$1,795.61

Mine Safety Appliances (NYSE: MSA  )

12/21/2012

36

$1,504.96

$1,675.80

Microsoft

12/26/2012

55

$1,499.15

$1,899.70

Hasbro (NASDAQ: HAS  )

12/28/2012

43

$1,520.60

$1,927.69

NV Energy (NYSE: NVE  )

12/31/2012

84

$1,504.72

$1,970.64

United Parcel Service

1/2/2013

20

$1,524.00

$1,729.60

Walgreen (NYSE: WAG  )

1/4/2013

40

$1,501.80

$1,768.00

Texas Instruments (NASDAQ: TXN  )

1/7/2013

47

$1,515.70

$1,637.95

Union Pacific (NYSE: UNP  )

1/22/2013

6

$805.42

$925.68

CSX (NYSE: CSX  )

1/22/2013

34

$712.50

$788.46

McDonald's (NYSE: MCD  )

1/24/2013

16

$1,499.64

$1,584.00

Becton, Dickinson (NYSE: BDX  )

1/31/2013

18

$1,518.64

$1,778.94

AFLAC (NYSE: AFL  )

2/5/2013

27

$1,466.35

$1,569.24

Air Products & Chemicals (NYSE: APD  )

2/11/2013

17

$1,510.99

$1,556.69

Raytheon 

2/22/2013

27

$1,473.91

$1,785.24

Emerson Electric

4/3/2013

28

$1,548.12

$1,527.12

Wells Fargo & Co (NYSE: WFC  )

5/30/2013

37

$1,525.48

$1,526.99

Kinder Morgan (NYSE: KMI  )

6/21/2013

42

$1,518.37

$1,602.30

Cash

     

$254.50

Total Portfolio

     

$34,220.22

Data from the iPIG portfolio brokerage account as of June 28, 2013.

Not bad for a strategy based on ideas that are nearly a century old.

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Read/Post Comments (5) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 01, 2013, at 8:01 PM, bestwaytoriches wrote:

    I think the chart is going to over ride your Gram theory and WAG $ 44 is coming down fast. Resting spot $ 37 To much debt and slow growth and way over valued. On the other had RAD $ 2.77 PE 9 and Price to sales .09

  • Report this Comment On July 01, 2013, at 8:08 PM, bestwaytoriches wrote:

    You best look at WAG chart all your pumping not going ot stop this falling knife. Face it WAG is a great Co. but way over valued and must retrace to $ 37 This will bring it back to fair value.

  • Report this Comment On July 01, 2013, at 11:50 PM, TMFBigFrog wrote:

    Hi bestwaytoriches,

    Thanks for your feedback. It's interesting you mention $37 as a target price for Walgreen's stock. Based on the iPIG portfolio's purchase price for the stock & the dividends already received, if the stock falls to $37, the iPIG portfolio would still be around break-even on a pre-tax basis.

    As such, your argument somewhat illustrates the benefit of the Graham-inspired methods used to pick the holdings for the iPIG portfolio. Even if I'm wrong and you're right, the portfolio wouldn't really lose money on the position.

    By the way, the last time I ran a valuation estimate on Walgreen (in May -- see this video article for details: http://www.fool.com/investing/dividends-income/2013/05/14/is... ), I estimated the company's intrinsic value was about $47.3 billion. That was before the recent earnings miss. I haven't had a chance to update the valuation estimate since the miss, but it's on the rotation to review that holding again.

    Best regards,

    -Chuck

    <I>Inside Value</I> Home Fool

    <B>Disclosure</B> I own shares of Walgreen's.

  • Report this Comment On July 02, 2013, at 7:54 AM, bestwaytoriches wrote:

    Time will tell watch the charts. IF RAD PE is 9 then WAG must come down to meet half way watch and RAD will go up.

  • Report this Comment On July 03, 2013, at 3:47 AM, Yamatoaktau wrote:

    Not sure about the volatility but the return on your portfolio is almost the same as the market's (SPY' YTD is about 14%), even though I know you kept buying stocks during this 6 month period. Anyways, how about your volatility (st. dev.) and Max drawdown during the period?

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