By several measures, such as the Tobin’s Q and Shiller P/E, the stock market looks expensive at current levels. The S&P 500 troughed at 666 in March of 2009. And at its present level, the S&P has increased over 215 percent. In light of this impressive run in stocks, the duration of this bull market and overall valuations, investors should consider whether stocks still have potential for solid returns going forward.

Returns over the next five to seven years will probably be lower than the that past five years. I believe investors can get a better chance for excess stock market returns by following the strategies of the investing greats. I have tracked portfolios since 2003 on my research site using the fundamental stock-picking methods of some of the best and most profitable investors. One of them is based on the works of Ben Graham, Warren Buffett’s mentor and the father of value investing.  

To be sure, stock market valuations today would probably have been too lofty for Graham’s liking. His talent for buying businesses that were underpriced versus the real value of their companies earned an annualized gain of 20 percent on average between 1936 to 1956. That’s while the S&P returned 12.2 percent annually on average over the same period.  

As I have captured quantitatively, Graham’s defensive investor strategy screens for a  price-to-earnings ratio of less than 15, based on trailing three-year earnings. The price-to-book value must be small enough that multiplying the P/E by the P/B comes to less than 22. The likelihood of losses is lowered by investing when stocks are changing hands at a discount to their intrinsic value.

Earnings growth have to be at least 30 percent the trailing 10 years, showing the company is a persistent performer. Any negative earnings the previous five years is unacceptable. The long-term debt must be less than working capital/net current assets, or current assets minus current liabilities. Total debt must be lower than total liabilities for a debt-to-equity ratio of less than 100 percent. Utilities, however, can have D/E ratios as high as 230 percent.

Assets, such as accounts receivables and cash, have to be at least double liabilities, for a current ratio of 2. The greater the current ratio, the less likely the business will incur financial problems. But watch out for companies that have high current ratio stemming from troubles collecting payments.

Graham favored large companies with at least $50 million in yearly sales in his day, which would be about $340 million today after adjusting for inflation.  He eschewed hot stocks and technology because he found them too risky. Financials failed to meet his requirements because of high high debt levels. Investing in a stock meant buying a whole company outright, including its future sales, earnings, debts and assets.

Finding stocks that meet 90 percent to 100 percent of the criteria above can be a challenge because the value requirements are so restrictive. But the 10-stock annual rebalanced portfolio I track on my research site has returned 13.6 percent annually since July 15, 2003, compared to 6.5 percent for the market (excluding dividends). Stocks that fit the model today are mostly beaten down oil or energy-related plays, like National Oilwell Varco (NOV), Helmerich & Payne (HP) and a few other names like Fossil (FOS) and Universal Corp (UVV).

Historically, the model has achieved a 56 percent accuracy rate, which means that 5.6 out of every 10 positions in the portfolio over the last 12 years have appreciated in price. Graham’s investment approach still works by finding “cigar-butt” value opportunities. But it takes discipline, a steadfast belief in the approach and a long-term perspective.

Calling market tops and making economic forecasts can be difficult and few people get it consistently right over time. But following a bottom’s up, fundamentally-oriented approach based on the investing greats, who have left their blueprints for success, can give investors the best chance for strong long-term returns.

John Reese is the founder of Validea Capital Management, the investment advisor to a new actively managed equity ETF that utilizes the strategies of legendary stock market investors​.​