Thursday, June 21, 2012

The Intelligent Investor

It's time for another installment in my The Intelligent Investor series.

On page 348, Graham covers his seven statistical requirements for inclusion in the defensive investors portfolio. His seven criteria are:

1. Adequate Size of the Enterprise
2. A Sufficiently Strong Financial Condition
3. Earnings Stability
4. Dividend Record
5. Earnings Growth
6. Moderate Price/Earnings Ratio
7. Moderate Ratio of Price to Assets.
Today we'll cover 1-3 and the next post will cover 4-7.

1. Adequate Size of the Enterprise - At the time of writing Graham set minimum of $100 million in annual sales. He did acknowledge that the value is rather arbitrary but his idea was to exclude small cap companies from the field since they are less stable and can come and go faster than you can blink. Since it's been quite a few years from his writing I would look at companies that are included in the S&P 500 index or DJIA.

2. A Sufficiently Strong Financial Condition - Graham has two criteria to determine passing of this condition. The first is that Current Assets be at least twice Current Liabilities, or a Current Ratio of 2+. The second is that long term debt does not exceed the net current assets. While I don't have an issue with a current ratio a little lower than 2, I do want to see it at least at 1. The long term debt being less than net current assets is a great metric since it shows that the company can service its' debt if it stumbles upon some difficult time.

3. Earnings Stability - His requirement here is pretty straight-forward, earnings for the common stock for 10 years. It's a fairly simple requirement that the company have positive earnings for the previous 10 years and is a good metric for the previous 10 years which include 2 recessions. If a company has positive earnings over that time span it's another notch in its belt.

I am going to start including some of these criterion in my stock analysis spreadsheets from now on.

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