Now we’ll look at the other perspective – analyzing stocks as an enterprising investor. What makes an enterprising investor different?

According to Graham, the enterprising investor is willing “to devote time and care to the selection of securities that are both sound and more attractive than the average.” In other words, this person is willing to put in the extra effort necessary to obtain a better than average return on investment. So if this describes you, what criteria do you use to analyze stocks for your portfolio?

Here are the six criteria that Graham suggests you follow:

Low Price/Earnings Ratio

The first criteria he suggests is a lower price/earnings ratio. As opposed to the defensive investor, who is advised to filter out stocks with a P/E ratio greater than 15, the enterprising investor is even more restricted. Only stocks with a P/E ratio of 9 or less are suitable.

Good Financial Condition

While the defensive investor looks for companies whose current assets are at least twice their current liabilities, the enterprising investor can be more flexible. Companies only need to have current assets that are one and a half times greater than their current liabilities to be sufficient for the enterprising investor.

Furthermore, the amount of debt is permitted to be within 110% of net current assets.

Earnings Stability

Again, Graham was more lenient in this area compared to the defensive investor. For the enterprising investor, he only required positive earnings over the previous five years.

Growth In Earnings

Graham didn’t require a specific percentage increase in earnings, as he did for the defensive investor. Rather, he only required that the company’s earnings from the previous year be more than its earnings figure five years ago.

Some Current Dividend

Graham was the most accommodating with this set of criteria. He didn’t insist on consistent dividend payments over a certain time period, but only expected some amount of current dividends.

Moderate Price

This was the only other criteria in which Graham placed more restrictions for the enterprising investor. To be a worthy company, the stock’s price needed to be less than 120% of the company’s tangible book value.

Closing Thoughts

Using this different set of criteria, enterprising investors would expand their list of suitable stocks for further analysis. However, Graham reminds us that to be successful, the enterprising investor must have enough knowledge of stock values to treat his operations as a business.

Do you consider yourself an enterprising investor? What other criteria do you use to analyze stocks?

This post was included in the Carnival Of Money Stories  during the week of July 19, 2010. Check out The Financial Blogger’s blog for a variety of great articles!

In the book, Graham makes a distinction between a defensive investor and an enterprising investor. A defensive investor has two main goals:

1. Avoid serious losses, and
2. Have freedom from effort and the need to make frequent decisions.

Here are seven criteria that he suggests we follow to help us find a quality stock as a defensive investor.

Adequate Company Size

Since smaller companies are more vulnerable to market fluctuations, Graham thought they were inappropriate for the defensive investor. So when he first wrote the book in 1949, he suggested focusing on stocks of companies with at least $100 million in annual sales. If the company is a public utility, he lowered the requirement to $50 million in total assets.

Jason Zweig, who wrote commentary on an updated version of Graham’s book, advised screening out stocks with a total market value of less than $2 billion.

Strong Financial Condition

Financial condition is measured by the company’s current ratio – calculated by dividing current assets by current liabilities. Graham believed that if a company’s current assets were at least twice their current liabilities, the company would be strong enough to withstand hard times.

He also advised that long-term debt shouldn’t exceed net current assets (current assets minus current liabilities). Using these filters, the list of suitable companies would be narrowed down to those that were conservatively financed and had staying power.

Earnings Stability

To be considered a solid stock, Graham wanted the company to have had positive earnings in each of the previous ten years.

Earnings Growth

Earnings alone were not sufficient for Graham to consider a stock safe for the defensive investor. In addition, over the previous ten years, the company should have increased its earnings per share by a total of 33%.

A Consistent Record Of Dividends

Graham also insisted on uninterrupted dividend payments over the past 20 years. Though it’s no guarantee that the company will continue to do so indefinitely, it’s a sign in the positive direction.

Moderate Price/Earnings Ratio

The current price shouldn’t be more than 15 times greater than the average earnings over the past three years.

Moderate Price/Book Value Ratio

Similarly, the current price shouldn’t be more than one and a half times the book value.

But to allow for some flexibility, Graham suggests that the product of the price/earnings ratio and the price/book value ratio shouldn’t exceed 22.5.

Applying The Criteria

With this knowledge, there are many stock screeners available to help you analyze stocks. I like to use Yahoo’s Stock Screener. Though it doesn’t have the capability to filter stocks using all seven criteria specifically, most are available to point you in the right direction. From there, you can dig deeper by using the SEC’s EDGAR database to find a company’s annual reports.

Do you invest in individual stocks? If so, what criteria do you use to choose them? Do you use a particular stock screener?