Graham's 50-year study -- foolproof?

Extracted from The Graham Investor.

In 1976, Hartman L. Butler spent an hour with Benjamin Graham and the interview is recorded within a fine study of Graham’s life published by The Financial Analysts Research Foundation. During the interview, Graham describes buying groups of stocks that meet some simple criterion for being undervalued, regardless of the industry and without detailed investigation of the individual company. This was anathema to his earlier method – as described in Security Analysis – of going through each stock with a fine-tooth analytical comb.
In the interview Graham mentions an article on three simple methods applied to selecting common stocks which was published in a 1975 seminar proceedings. In connection with this statement, he also mentions a 50 year study he had just completed:

“I am just finishing a 50-year study–the application of these simple methods to groups of stocks, actually, to all the stocks in the Moody’s Industrial Stock Group. I found the results were very good for 50 years. They certainly did twice as well as the Dow Jones. And so my enthusiasm has been transferred from the selective to the group approach.”

… “Imagine–there seems to be practically a foolproof way of getting good results out of common stock investment with a minimum of work. It seems too good to be true. But all I can tell you after 60 years of experience, it seems to stand up under any of the tests that I would make up. I would try to get other people to criticize it.”

Basically the three simple methods (tested separately) were:

1. Look for stocks with Earnings Yield, i.e. E/P twice the prevailing AAA Corporate Bond interest yield (albeit limiting P/E no greater than 10, and no lower than 7, regardless of the bond rate).
2. Look for stocks making a low around 50% of their two year high.
3. Price at two-thirds of book value.

In the article, Graham tabulates the results for all three methods; each method beats the index by a considerable margin, with the P/E method being the best, the 2-year low being second-best.

I found it interesting to read about the 2-year high/low study, because I have previously mentioned the need to pick stocks from the screen that are well off their previous highs – so we know there is sufficient upside potential to make a serious profit. In other words, if a stock on the screen is at $2, but only ever got as high as $2.50 in its history, it would not apparently have as much upside potential as a similarly-priced stock that once hit $10. It would seem from reading these studies that Graham himself also found this to be true and allowed himself room for at least a 50% return.

It’s also important to remember that in this study, Graham was advising the purchase of a basket of around 30 stocks matching any one criteria of undervaluation, e.g. 2/3 of book. He even went so far as to say “You can’t lose when you do that.” His experience proved that buying a stock at such a criteria was a dependable indication of group undervaluation.

Sovereign Investor:  A normal institutional or SWF wouldn't restrict itself to such a portfolio, but the underlying drivers may nonetheless of interest to investors seeking exposure to the value factor. The original article at The Graham Investor has sparked off a lively discussion.