What is Benjamin Graham's Defensive Investor strategy?
Benjamin Graham's Defensive Investor strategy is a rules-based stock screen for investors who want financially sound companies without tracking the market closely. It keeps only larger companies with a strong balance sheet, a long record of positive earnings and dividends, steady earnings growth, and a moderate price: a P/E cap and a cap on P/E multiplied by price-to-book. Graham set out the rules in The Intelligent Investor; the modern version below adapts his size and history thresholds.
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Graham, Warren Buffett's teacher, defined the goal this way: "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative." The Defensive Investor screen is stricter than his Enterprising Investor approach, which looks for unpopular companies, special situations, and bargain issues.
Defensive Investor screen rules
Each rule below is the modern adapted threshold, with Graham's original in parentheses where it differs:
- Adequate size: at least $500 million in sales over the trailing 12 months. (Graham used $100 million in sales and at least $200 million in total assets.)
- Strong financial condition: a current ratio (current assets divided by current liabilities) of at least 2.0, and long-term debt lower than working capital.
- Earnings stability: positive earnings in each of the past seven years. (Graham required 10 years.)
- Dividend record: dividends paid in each of the past seven years. (Graham required 20 years.)
- Earnings growth: earnings growth of at least 3% a year, compounded, over the past seven years. (Graham required a one-third gain in earnings per share over the latest 10 years.)
- Moderate P/E ratio: an average P/E of 17 or lower over the past three years. (Graham used 15 times average earnings.)
- Moderate price to assets: P/E multiplied by price-to-book below 25.5. Graham also suggested price should generally not exceed 1.5 times book value.
- Sector exclusions: the general version of the screen excludes utilities and retailers.
Using the MarketXLS Defensive Investor template
The MarketXLS template compares a company's key metrics and ratios with the Defensive Investor thresholds and shows which rules the stock passes. Enter a stock ticker in cell C4. The template's description states it is set up for companies in the Utilities sector, while the general rule list above excludes utilities, so check the template's thresholds before relying on a result.
Limitations: the screen uses past financial data, and a stock that passed in the past may not produce the same results in the future.
*Enter Stock Ticker at cell C4.
Why Graham chose a P/E limit of 15
Graham tied his P/E limit to bond yields. When he wrote the rules, AA-rated bonds yielded about 7.5%. The inverse of that yield is 13.3, which he used as the target P/E for the portfolio as a whole, with a maximum of 15 times average earnings for any single stock. Graham summarized his philosophy as analyzing potential purchases on sound business principles, avoiding risk to a substantial part of your capital, and sticking to your own judgment regardless of market opinion.
Disclaimer: None of the content published on marketxls.com constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. The author is not offering any professional advice of any kind. The reader should consult a professional financial advisor to determine their suitability for any strategies discussed herein. The article is written for helping users collect the required information from various sources deemed to be an authority in their content. The trademarks if any are the property of their owners and no representations are made.
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