Using Graham's Theories to Find Attractive Defensive Stocks

Periodically, Standard & Poor's provides a list of stocks under certain screening or factor assumptions. This week's featured screen attempts to uncover stocks that Benjamin Graham may have found as attractive investments. Benjamin Graham noted the following characteristics for selecting attractive defensive stocks:

Graham believed that the defensive investor should select between 10 and 30 stocks that each have the following characteristics: large, prominent, and conservatively financed, with long records of continuous dividend payments. Such stocks should be purchased at attractive prices. As a yardstick, Graham suggested that the investor pay no more than 25 times average earnings over the past seven years, and no more than 20 times earnings over the last 12 months.

In order to create a factor screening model based on the above characteristics, Richard Tortoriello, a S&P Equity Analyst and author of Quantitative Strategies for Achieving Alpha, ran the screen on companies with a S&P Quality Ranking (pdf file) greater than B+. S&P's database contains 430 U.S. companies with a Quality Ranking greater than B+. The specific screening factors used by Tortoriello are as follows:

• S&P Quality Ranking > B+
• 3-Year Average ROE > 18%
• Total Debt to Invested Capital < 20%
• Enterprise Value to 3-Year Average EBIT < 7
• Free Cash Flow to Invested Capital > 40%

The companies resulting from the screen are detailed in the below table.

click to enlarge

Source:

• Exploring Quantitative Strategies ($), The Outlook, Standard & Poor's, By: Richard Tortoriello, S&P Equity Analyst, February 25, 2009.

Comments

[Steve in Gr...:]

Thanks, Mr. Templeton, for your article. Of the seven that made it through the filter (which looks backward), only XOM and CVX are really attractive to me on a forward-looking basis, and even they have substantial political risk.

Feb 22 11:30 AM

[Graham Jervis:]

I like PAYX, zero debt, well managed with a wide economic moat. should be able to ride out this economic storm fully intact and in a position to seize opportunities that may arise out of this hardship the world is going thru.

Feb 22 01:08 PM

[Moon Kil Woong:]

Nice to know some people still follow Graham in these days. Although it won't call a market bottom, it sure beats the dart throwers out there.

Feb 23 03:06 AM