Graham’s Defensive Stock Criteria:
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 three years and get an average, the last three years and get an average and then base his 10-year earnings growth on those two numbers. I will be using five-year rates.
7. The price/earnings ratio should not be more than 15 over the past three 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.
Regal-Beloit (RBC) currently meets all of these criteria. Regal-Beloit is one of the world’s largest industrial and commercial electric motors and generators and is currently in the portfolio’s of the following investing gurus:
1. Market Cap is $ 1,931 million
2. Current ratio of 2.5
3. LTD is less than working capital
4. 10 years of positive earnings with growth
5. Dividends continuous for 10 years with an average of 4.5% yearly growth
6. Cumulative earnings greater than 150% over the last 10 years and 11% over the last 5 years.
7. P/E is 12.2
8. With a P/B of 1.3, (1.3 x 12.2 = 15.86), meets Graham’s final criteria
Add to these following qualities and you have a stock worthy of more investigation.
· Increasing net profit margins
· Steadily rising book value
· Decreasing debt to equity over the last several years
· P/S of 0.9
· GuruFocus predictability rating of 3.5
· Positive free cash flow over 10 years