7 Principles Worth Revisiting For The Defensive Investor

by: Pey Shadzi

I'll save you the time and just come right out and say it: I'm a Warren Buffett junkie. From his stock picks to the books written about him to the annual letters...I really just can't get enough of following Buffett.

So a few years ago when I noticed Warren Buffett touted Benjamin Graham's The Intelligent Investor as "the best book on investing ever written," I certainly took notice. After scanning the cover and delving deep into the subject of value investing, I was hooked. After reading cover to cover of The Intelligent Investor, I couldn't help but turn the book over and begin reading from page one once again. I now make it a habit to review Graham's masterpiece on a monthly basis. Though the original copy of the book was written in the 1970s, I would argue the principles are even more applicable today as they were many decades ago.

One chapter which I found particularly useful was his chapter regarding stock selection for the defensive investor. Here are seven principles Graham spoke about that are certainly worth revisiting:

1. Choose an enterprise with adequate size. Graham's preference for larger companies was a tactful way of avoiding firms that had the potential to not make it through difficult economic times. Due to the sheer mega market capitalization of Exxon Mobil (NYSE:XOM), it's unlikely the oil giant will fall over the likes of a penny stock with a market capitalization of $50 million.

2. Look for companies with strong financial conditions. Graham looked for companies with current assets at least twice that of current liabilities, what he referred to as a "two-to-one current ratio."

3. The importance of earnings stability. A history of ten years of positive earnings helps weed out companies which may not possess long term viability.

4. Uninterrupted dividend records. A consistent dividend payment which spans several decades is a positive indicator that a company has the potential to do well in any type of economic situation. The 3M Company's (NYSE:MMM) consistent history of paying dividends shows strength and a positive long term trend.

5. Earnings growth. Graham looked for a minimum of at least one-third in per-share earnings over the past ten years using three-year averages at the beginning and end.

6. Moderate price/earnings ratio. Current price should not exceed more than 15 times average earnings for the past three years. Many great companies, such as Microsoft (NASDAQ:MSFT), Exelon (NYSE:EXC), Hasbro (NASDAQ:HAS), Intel (NASDAQ:INTC) and Caterpillar (NYSE:CAT) are trading at attractive multiples at the start of 2012.

7. Moderate ratio of price to assets. Current price should not be more than 1.5 times book value. Graham argued this principle suited the defensive investor well due to the fact it would exclude companies that are too small, in relatively weak financial condition, with poor ten year histories which failed to pay a consistent dividend.

For the defensive investor, Graham's timeless principles are paramount and it never hurts to revisit these basic value investing principles from Benjamin Graham, the man who earned the title of "the father of value investing."

Disclosure: I am long MSFT, MMM, XOM, EXC.