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Ben Graham's Defensive Approach

Benjamin Graham is known as the father of value investing and he described his method for defensive investors in his book The Intelligent Investor, which has been in bookstores for more than fifty years. While Graham passed away in 1976, an updated edition of The Intelligent Investor (ISBN 0060555661) is now in bookstores. The original text is thankfully presented in its entirety.

Graham's approach is value oriented and it's best described as a weeding out process. If a company passes all of Graham's tests then it qualifies for possible investment by defensive investors. It should be noted that Graham's defensive test does not apply to Financial stocks. It is also somewhat different when it comes to analysing industrials and utilities.

Graham's Original Rules of Defensive Investors

1. Adequate Size: Not less than $100 million in annual sales for an industrial company and not less than $50 million in total assets for a public company. (Note: These figures have not been adjusted for inflation.)

2. Sufficiently Strong Financial Condition: For industrials, current assets should be at least twice current liabilities and long term debt should not exceed net current assets. For utilities debt should not exceed twice the stock equity at book value.

3. Earnings Stability: Some earnings for the common stock in each of the past 10 years.

4. Dividend Record: Uninterrupted payments for at least the past 20 years.

5. Earnings Growth: A minimum increase of at least one-third in per-share earnings in the past 10 years as measured by three-year averages at both ends of the period.

6. Moderate Price/Earnings Ratio (P/E): Should be less than 15 times the average earnings of the past 3 years.

7. Moderate Ratio of Price to Assets (P/B): Current price should not be more than 1.5 the last reported book value.

8. Modification to Rules 6 & 7: The P/E multiplied by P/B < 22.5.

Simplified Graham Screen

We only use rule 8 for our basic Graham screens and the P/E used is based on the last year's worth of earnings.

Graham Inspired Rules

We've also run a more complicated version of the defensive screen for the Canadian MoneySaver magazine for many years. You can read the articles via the following links.

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