Screen with Ben Graham’s Lost Magic Formula in 1976
While reading these interviews he did between age 79 and 82, I got the feeling that Graham was enthusiastic as he described a new mechanical formula he had nearly finished testing. He believed his formula was the simplest way for both seasoned analysts and layman investors to find undervalued stocks and outperform the Dow (the performance metric used during his time).
His formula went through two iterations. He introduced the first formula at age 79 and concluded from his results that one would have performed quite well from 1961-1976 by buying stocks with the lowest values of these three criteria:
1. A low multiple (e.g.,10) of the preceding year’s earnings;
2. A price equal to half the previous market high (“to indicate that there has been considerable shrinkage”);
3. Net Asset Value. (I presume this is the lowest price relative to book value)
In his next interview published in Medical Economics, September 20, 1976 titled “The Simplest Way to Select Bargain Stocks” Graham, then 82, proposed a simpler, more refined formula that consisted of:
1. PE Ratio of 7x-10x or less (Based on 2x current AAA bond rates);
2. Equity/Asset Ratio of .5 or more (e.g. Debt/Equity less than 1).
Graham back tested the period from 1926-1976 with his refined formula and concluded that such a program would have earned 15% or more, not including dividends, and would have beaten the Dow by twice as much. He was so excited by the study results that he contemplated including them in the 5th edition of Security Analysis.
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