Graham Ratio: definition and statistics

I thought it was be fun to take a look at the "Graham Ratio". Here's how Sharelock Holmes defines it:

A Ratio used by Ben Graham the famous Value Investor. It is defined as the ratio of Net Current Assets minus non current liabilities to the Market Capitalisation. Graham was looking for companies with a ratio of less than two thirds. Very few shares meet his criteria these days.

Market Capitalisation /(Net Current Assets – Creditors Long – Provisions) 

I ran some numbers through their database. I pulled up all the companies in Sharelock's database with market caps >=£50M. There turned out to be 773 of them. This seemed to be suspiciously low. If you pull up all of the companies in their database, you get over 1000 of them. Quite a few of them are microscopically small: 0.5M in market cap, for example. I'm going to assume that the list of 773 is complete for the purpose of this exercise.

Of the 773 companies, 688 had non-null GRs (Graham Ratios). The null entries were banks and non-life insurance companies, plus a couple of strays. There quite a lot of banks and insurance companies on the stock market. I excluded non-nulls from further selection. The logic behind this is that if you want to apply a value-based approach to banks and insurers, then you should apply separate criteria.

439 of the 773 companies (just over half!) had negative GRs. I excluded them from further consideration - as the sheer quantity of them mean that they would dominate the percentile rankings.

So that leaves 249 companies out of 773 which have positive GRs. I ranked these companies in ascending GRs. Below I present a table of the percentile and GR:

%     GR
P05  1.0
P10  1.5
P20  2.9
P40  6.3
P60 11.2
P80 24.5

So P05 means the 5th percentile, P10 means the 10th percentile, and so on. I have concentrated on quintiles - but of course we are mostly interested in what's at the bottom of the barrel, or top, depending on how you look at it.


Here is a table of the top 20%:

EPIC	Share_Name	MarketCap	Last_Price	Sector	Graham_Ratio
RCG	RCG HOLDINGS	88.03	30.25	ELECTRONIC AND ELECTRICAL EQUIPMENT	0.43
BDEV	BARRATT DEVELOPMENTS	765.55	79.3	HOUSEHOLD GOODS AND HOME CONSTRUCTION	0.49
GLE	GLEESON (M J)	53.95	102.5	CONSTRUCTION AND MATERIALS	0.66
TW.	TAYLOR WIMPEY	830.1	25.97	HOUSEHOLD GOODS AND HOME CONSTRUCTION	0.67
BVS	BOVIS HOMES	452.37	339.7	HOUSEHOLD GOODS AND HOME CONSTRUCTION	0.7
BWY	BELLWAY	650.71	538.5	HOUSEHOLD GOODS AND HOME CONSTRUCTION	0.82
ABBY	ABBEY	91.16	370	HOUSEHOLD GOODS AND HOME CONSTRUCTION	0.82
PSN	PERSIMMON	1084.57	360.2	HOUSEHOLD GOODS AND HOME CONSTRUCTION	0.87
MTVW	MOUNTVIEW ESTATES	154.06	3950	REAL ESTATE INVESTMENT AND SERVICES	0.92
RDW	REDROW	318.76	103.3	HOUSEHOLD GOODS AND HOME CONSTRUCTION	0.96
PMHL	PROSPERITY MINERALS HOLDINGS	159.72	113	CONSTRUCTION AND MATERIALS	0.96
SGR	SHORE CAPITAL	69.65	28.5	FINANCIAL SERVICES	1.01
GFRD	GALLIFORD TRY	233.4	285.25	CONSTRUCTION AND MATERIALS	1.03
POL	POLO RESOURCES	124.62	5.13	FINANCIAL SERVICES	1.11
BMY	BLOOMSBURY PUBLISHING	85.11	115.25	MEDIA	1.18
FCCN	FRENCH CONNECTION	51.04	53.25	GENERAL RETAILERS	1.19
TRE	TRADING EMISSIONS	220.04	85.5	FINANCIAL SERVICES	1.19
NUM	NUMIS CORPORATION	127.54	114	FINANCIAL SERVICES	1.23
RAB	RAB CAPITAL	63.54	13.5	FINANCIAL SERVICES	1.3
CHNS	CHINA SHOTO	59.76	256	ELECTRONIC AND ELECTRICAL EQUIPMENT	1.32
BKG	BERKELEY GROUP HOLDINGS	1095.6	834.5	HOUSEHOLD GOODS AND HOME CONSTRUCTION	1.38
GFM	GRIFFIN MINING	61.62	34	MINING	1.38
PLAZ	PLAZA CENTERS NV	310.36	106	REAL ESTATE INVESTMENT AND SERVICES	1.47
PRX	PROXIMAGEN NEUROSCIENCE	83.33	145.25	PHARMACEUTICALS AND BIOTECHNOLOGY	1.55
CWR	CERES POWER	63.76	74	ELECTRONIC AND ELECTRICAL EQUIPMENT	1.76
CSR	CSR	584.25	324.1	TECHNOLOGY HARDWARE AND EQUIPMENT	1.77
BLZ	EMBLAZE	50.54	45.25	SOFTWARE AND COMPUTER SERVICES	1.79
CPS	CPL RESOURCES	75.35	202.5	SUPPORT SERVICES	1.81
RNVO	RENOVO GROUP	69.55	36.5	PHARMACEUTICALS AND BIOTECHNOLOGY	1.85
DQE	DQ ENTERTAINMENT	51.79	144	MEDIA	1.94
TMW	TIMEWEAVE	55.22	24.5	SOFTWARE AND COMPUTER SERVICES	1.95
EVG	EVOLUTION GROUP	188.15	81	FINANCIAL SERVICES	2.07
SIG	SIGNET JEWELERS	1915.64	2236	GENERAL RETAILERS	2.08
EAGA	EAGA	148.97	59.25	SUPPORT SERVICES	2.1
PVCS	PV CRYSTALOX SOLAR	220.81	53	ALTERNATIVE ENERGY	2.1
CLST	COLLINS STEWART	197.07	79.5	FINANCIAL SERVICES	2.18
NEO	NEOVIA FINANCIAL	71.36	59.5	FINANCIAL SERVICES	2.27
TFW	THORPE (F W)	80.87	690	ELECTRONIC AND ELECTRICAL EQUIPMENT	2.28
ACL	ACAL	65.6	230.75	SUPPORT SERVICES	2.29
BOR	BORDERS AND SOUTHERN PETROLEUM	300.99	70.25	OIL AND GAS PRODUCERS	2.3
ORA	ORA CAPITAL PARTNERS	70.25	106.25	FINANCIAL SERVICES	2.32
ERE	EREDENE CAPITAL	50.44	18	REAL ESTATE INVESTMENT AND SERVICES	2.33
NORK	NORKOM GROUP	84.87	94.5	SOFTWARE AND COMPUTER SERVICES	2.48
BVC	BATM ADVANCED COMMUNICATIONS	90.24	22.5	TECHNOLOGY HARDWARE AND EQUIPMENT	2.55
PON	PSION	132.14	94	TECHNOLOGY HARDWARE AND EQUIPMENT	2.61
HTG	HUNTING	846.26	640	OIL EQUIPMENT - SERVICES AND DISTRIBUTION	2.66
CNKS	CENKOS SECURITIES	68.93	101	FINANCIAL SERVICES	2.72
ITL	INTEC TELECOM SYSTEMS	226	71.75	SOFTWARE AND COMPUTER SERVICES	2.86
KEA	KEA PETROLEUM	53.41	10.5	OIL AND GAS PRODUCERS	2.92
SEY	STERLING ENERGY	149.7	68.25	OIL AND GAS PRODUCERS	2.98

Interesting reading.

There are only 4 companies that satisfy Ben Graham's value criterion. Of those 4 companies, 3 are housebuilders. The whole of the top of the list is choc full of housebuilders. This is not terribly surprising considering that housebuilding has taken a tumble due to economic times, and the fact that WIP on house construction is shown as part of the current assets. Housebuilders carry a lot of WIP/stock of houses!

So, using this criterion is likely to be rather unsatisfying, and I definitely that an investor should buy a whole bunch of housebuilders. In order to produce adequate diversification, an investor will have to start selecting companies lower on the list. A cut-off of 1.5 seems to low to ensure adequate diversification. A cut-off point at around 3 would seem sensible.

My own take on this is that the basic idea is good, but I think it is very difficult to practice under current circumstances - and dangerous to practice under his strict criterion. The market is not especially high at the moment, so one would think that there would be a fair selection to choose from. However, this does not appear to be the case. The Investors Chronicle has an annual selection using the Graham Ratio idea. Alas, I can't find a reference just now. They don't apply the strict criterion - it's too limiting - but they go up to about 1.5. I suspect that they are using a better database than me. My recollection is that the performance of their model portfolios has been resoundingly excellent. I seem to recall that Stingy Investor has been running a similar portfolio for many years, and has produced returns clearly superior to the market.