How To Pick Stocks Like Benjamin Graham – The Enterprising Investor
In the previous post, we briefly mentioned two different types of investors – the defensive investor, and the enterprising investor. Then we defined who a defensive investor was, and looked at how to analyze stocks as a defensive investor.
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.
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.
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.
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.
Finally, if you want to get at the heart of what Graham’s value investing perspective, consider reading a copy of his book The Intelligent Investor. The work was first published in 1949 and has been a must read for value investors since then. It sells for something like $12.00 on Amazon, so it is inexpensive considering its educational value.
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!