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 (BDX -1.22%) 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 (WBA -1.43%) 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 (HAS -0.51%), 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 (BRK.B -0.32%) 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:

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.