How would Benjamin Graham invest internationally?

Benjamin Graham is the second most famous investor in the world, surpassed only by his pupil Warren Buffett. Such was his influence on Buffett, Buffett named his son, Howard Graham after his mentor. Benjamin Graham’s magnum opus is his book on value investing, ‘The Intelligent Investor’. In his preface to the fourth edition, Buffett calls the book, “the best book about investing ever written.”

The book details how investors can avoid the trappings of becoming speculators. Graham defines investors as those that seek the preservation of the principal of their investment and an adequate return. Investment decisions not having these objectives, Graham says are made by speculators and are exposed to higher risks and costs. Investors invest for the long term, through the market cycle.

According to the book the term long-term investor is redundant. There is only one kind of investor. 

“Someone who can’t hold their investment for more than a few months at a time is doomed to end up not as a victor but as a victim.”

The book is littered with examples of the shortfalls of attempting to time the market. Markets are unpredictable. The challenge for investors is to find and stick to an approach that captures growth beyond the average returns of markets. This is easier said than done. Graham suggests a number of ways for investors to go about this.

A recurring theme of ‘The Intelligent Investor’ is that investors should demand from a company “a sufficiently strong financial position and the prospect that its earnings will at least be maintained over the years.”

Graham defines a strong financial position as one in which long-term debt does not exceed current net assets and a high return on equity (ROE). Graham argues the best way to determine the prospect that earnings will be maintained is to examine the earnings of the company for the past ten years.

It would be impossible for “intelligent” Australian investors diversifying internationally to analyse these characteristics for each company around the world.

MSCI, one of the world’s largest index providers, does the work for us. MSCI analyses the stocks in its global universe and identifies the companies with the strongest fundamentals for inclusion in its ‘Quality’ Indices.

According to MSCI, “Quality growth companies tend to have high ROE, stable earnings that are uncorrelated with the broad business cycle, and strong balance sheets with low financial leverage.”

MSCI’s description matches the characteristics Graham insists investors should demand from companies and is the basis for the MSCI’s World ex Australia Quality Index.

MSCI only includes the highest scoring, top 30% by market capitalisation of its global universe. MSCI Quality scores are based on three fundamental factors:

1. ROE;
2. Earnings variability; and
3. Debt to equity ratio.

The long-term results of Graham’s practices are well documented and evidenced by the ongoing success of his many high-profile pupils.

Given Graham’s most famous student famously told his own investors that they would be better off investing in low-cost index funds, we think for international equities, Graham would have invested in QUAL (ASX: QUAL).

ETF

VanEck MSCI International Quality ETF (QUAL)

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