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Benjamin Graham and some Defensive Picks

June 04, 2011 | About:
David Chulak

David Chulak

30 followers
In the difficult economic times we are facing, many investors get anxious about the direction of the market and often seek shelter by withdrawing all of their funds to safety. Value investors instinctively know better and realize that they should “buy on the dips”, however; when dealing with savings, many behavioral bad habits take over and we can sometimes panic.

Benjamin Graham proposed several methods of choosing stocks over his incredible career. One such method was designed for the defensive investor, rather than the more enterprising individuals. Below is a quick introduction to the methodology and some stocks for consideration and for more study. Ideally, a stock should possess all of the following traits, though Graham alluded to the fact that a stock may not meet all 7 criteria. The idea behind this type of portfolio was for investors interested in low maintenance with some built-in protection for debt, conservative financing, etc., with the ultimate goal of affording the defensive investor some added safeguards to their portfolio.

1. Graham wanted companies that were not too small for the defensive type person and suggested companies that had not less than $100 million of annual sales ($50 million for a public utility). Today, that number would probably best be translated to at least $300 million in today’s dollars.

2. A current ratio of at least 2-1. The current ratio is the ratio produced by taking current assets and dividing them by current liabilities.

3. Long–term debt should be equal to or less than net current assets or basically, long-term debt less than working capital.

4. Earnings stability, meaning that there should be positive earnings for each of the last 10 consecutive years.

5. Twenty years of dividend payment. This becomes more difficult today, because of the vast number of companies reinvesting large portions of their earnings back into the company. Today we would be happy to find companies with a dividend history of 7-10 years.

6. Earnings growth of approximately 30-33% over a 10 year period or approximately 3% per year. If you read carefully, Graham did not take the first and last year to discover his average. He would take the first 3 years and get an average, the last 3 years and get an average and then base his 10 year earnings growth on those two numbers. I will be using 5 year rates.

7. The price/earnings ratio should not be more than 15 over the past 3 years.

8. Finally, he suggested that the price to book value not exceed 1.5, however; he allowed for a slight alteration if multiplying the P/B times the P/E did not produce a product greater than 22.5. Therefore, as an example; this would allow a p/b of 2 and a P/E of 9, resulting in a slightly higher P/B, but allowed under this method.

Below is a small representation of stocks that meet Graham’s defensive strategy. Keep in mind that there are many other reasons these stocks may be great buys. Enjoy the research!

Weis Markets, Inc. (WMK)

Sales: $2620

Current Ratio: 2.3

LTD: None

Earnings Stability: 10 years of positive earnings

Dividends: 10 years minimum with a 3.01% dividend yield

Earnings Growth: 5.25% per year (5 years)

P/E: 15

P/B: 1.5

P/E x P/B = 22.50

Intel (INTC)

Sales: $46,171

Current Ratio: 2.0

LTD: Less than working capital

Earnings Stability: 10 years of positive earnings

Dividends: 10 years minimum with a 3.11% dividend yield

Earnings Growth: 7.5% per year (5 years)

P/E: 9.7

P/B: 2.22

P/E x P/B = 21.53



Alamo Group Inc. (ALG)

Sales: $525

Current Ratio: 3.4

LTD: Less than working capital

Earnings Stability: 10 years of positive earnings

Dividends: 10 years minimum with a .97% dividend yield

Earnings Growth: 9.32% per year (5 years)

P/E: 15.1

P/B: 1.2

P/E x P/B = 18.12



Curtiss-Wright Corp (CW)

Sales: $1913

Current Ratio: 2.33

LTD: Less than working capital

Earnings Stability: 10 years of positive earnings

Dividends: 10 years minimum with a .99% dividend yield

Earnings Growth: 5.98% per year (5 years)

P/E: 13

P/B: 1.3

P/E x P/B = 16.90



If you have more questions about this methodology or other ideas, please feel free to contact me. Happy research!

About the author:

David Chulak
David Chulak is a private investor that uses a value approach to investing in the styles of Graham & Dodd and Warren Buffet. Looks for that margin of safety in an effort to preserve capital and attempts to guard against short term market fluctuations by having clear rules laid down in advance for selling an equity. Likes to visit the company's where his investments are in order to understand the business better.

Rating: 4.5/5 (11 votes)

Comments

D HOLT
D HOLT - 3 years ago
excellent article, very helpful
Adib Motiwala
Adib Motiwala - 3 years ago
Good stuff David. I am long INTC. I also like CW though not at this valuation...
davidchulak
Davidchulak premium member - 3 years ago
My apologies to all. I forgot to disclose that at the current time, I am only long on INTC from this list.

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