Warren Buffett, the second most wealthy individual in the U.S., has on many occasions accredited his success to Benjamin Graham's book, The Intelligent Investor. Considered by many to be the "father of value investing," Benjamin Graham has the record to back it up; from 1936 to 1956, Graham's firm achieved annualized returns of about 20%.
In chapter 14 of The Intelligent Investor, Graham outlines the criteria a defensive investor can use to select stocks. Using these criteria, a calculation called the Graham Number explained below, and with the help of Serenity's Screener, I was able to find four stocks I'd recommend for the defense investor: Baker Hughes (BHI), Cash America International (CSH), Helmerich & Payne Inc (HP), and HollyFrontier Corporation (HFC).
Defensive Investor Screening Criteria
- Not less than $100M of annual sales [$500M today due to inflation].
- Current assets should be at least twice current liabilities.
- Long-term debt should not exceed the net current assets.
- Some earnings for the common stock in each of the past ten years.
- Uninterrupted dividend payments for at least the past 20 years.
- A minimum increase of at least one-third in per-share earnings in the past ten years.
- Current price should not be more than 15 times average earnings.
- Current price should not be more than 1-1⁄2 times the book value.
Graham Number Explained
The Graham Number is derived from Graham's belief that a stock should never cost more than 15 times average earnings (point 7 above) and should never cost more than 1.5 book value (point 8 above). Using these two criteria, he created the following formula to help create an estimate of the stock's intrinsic value.
Source: Investopedia (for those of you wondering, the 22.5 is because 1.5 * 15 equals 22.5)
In order for the stock to meet criteria 7 and 8 above, the calculated Graham Number must be greater than the current price indicating it is undervalued.
4 Quick Picks Based off Defense Investor Criteria and Graham Number
Long Term Debt
Net Current Assets
Positive Earnings Past 10 Years
20 Years of Dividend Payments
The four quick pick stocks above meet all eight of the criteria for Benjamin Graham's defensive investor. The stock with the most upside potential is HFC, with the highest difference between the Graham Number estimate of intrinsic value and market price being 49%. However, since all the stocks offer at least 18% upside, I would recommend diversifying and buying balance positions in all of them.