Today's defensive investor can do even better-by buying a total stock-market index fund that holds essentially every stock worth having.
A low-cost index is the best tool ever created for low-maintenance stock investing-and any effort to improve on it takes more work (and incurs more risk and higher costs) that a truly defensive investor can justify.
Researching and selecting your own stocks is not necessary; for most people, it is not even advisable. However, some defensive investors do enjoy the diversion and intellectual challenge of picking individual stocks-and, if you have survived a bear market and still enjoy stock picking, then nothing that Graham could say will dissuade you.
In that case, instead of marking a total stock market index fund your complete portfolio, make it the foundation of your portfolio. Once you that foundation in place, you can experiment around the edges with your own stock choices.
Keep 90% of your stock money in an index fund, leaving 10% with which to try picking your own stocks. Only after you build that solid core should you explore.
Let's briefly update Graham's criteria for stock selection.
Adequate size.
Nowadays, "to exclude small companies," most defensive investors should steer clear of stocks with a total market value of less than $2 billion.
However, today's defensive investors-unlike those in Graham's day can conveniently own small companies by buying a mutual fund specializing in small stocks.
Strong financial condition.
Graham's criterion of financial strength still works: If you build a diversified basket of stocks whose current assets are at least double their current liabilities, and whose long-term debt does not exceed working capital, you should end up with a group of conservatively financed companies with plenty of staying power. The best values today are often found in the stocks that were once hot and have since gone cold. Throughout history, have often provided the margin of safety that a defensive investor demands.
Earning stability.
Graham's insistence on "some earnings for the common stock in each of the past ten years" remains a valid test-tough enough to eliminate chronic losers, but not so restrictive as to limit your choices to an unrealistically small sample.
Dividend record.
It's a comforting sign if the companies paid a dividend, have paid a dividend for at least 20 years in a row.
Earnings growth.
Graham set a very low hurdle; 33% cumulative growth over a decade is less than a 3% average annual increase.
Cumulative growth in earnings per share of at least 50% or a 4% average annual rise is a bit less conservative.
Cumulative growth in earnings per share of at least 50% or a 4% average annual rise is a bit less conservative.
Moderate P/E ratio.
Graham recommends limiting yourself to stocks whose current price is no more than 15 times average earnings over the past three years. Instead, calculate a stock's price/earnings ratio yourself, using Graham's formula of current price divided by average over the past three years.
Moderate price-to-book ratio.
Graham recommends a "ratio of price to assets" (or price-to-book-value ratio) of no more than 1.5.
In recent years, an increasing proportion of the value of companies has come from intangible assets like franchises, brand names, and patents and trademarks. Since these factors(along with goodwill from acquisitions) are excluded from the standard definition of book value, most companies today are priced at higher price-to-book multiples than in Graham's day.
What about Graham's suggestion that you multiply the P/E ratio by the price-to-book ratio and see whether the resulting number is below 22.5? Graham's "blended multiplier" still works as an initial screen to identify reasonably-priced stocks.
In recent years, an increasing proportion of the value of companies has come from intangible assets like franchises, brand names, and patents and trademarks. Since these factors(along with goodwill from acquisitions) are excluded from the standard definition of book value, most companies today are priced at higher price-to-book multiples than in Graham's day.
What about Graham's suggestion that you multiply the P/E ratio by the price-to-book ratio and see whether the resulting number is below 22.5? Graham's "blended multiplier" still works as an initial screen to identify reasonably-priced stocks.
- The Intelligent Investor, Benjamin Graham
