How to Invest for the Defensive Investor
This is based on Stock Selection for the Defensive Investor from Benjamin Graham’s Intelligent Investor a book we highly recommend to any person who has decided to venture past indexing and our How to Invest Correctly series and has decided to select individual securities. We strongly believe that if Benjamin Graham was alive today he would suggest that you do not select individual securities and even suggested setting up a Dow Jones Industrial Average type of portfolio which was basically suggesting how to create your own index fund. In today’s day and age you can do this for far less fees and much easier then doing it yourself by using a company like Vanguard and following the advice in our Invest Correctly series!
“Rule No. 1: never lose money; rule No. 2: don’t forget rule No. 1” -Warren Buffett
Selection Criteria for the Defensive Investor:
- Adequate Size of Market Cap No firm criteria as to size but most defensive investors should not bother with enterprises less then $2B in market cap.
- Strong Financial Condition Current assets at least twice their current liabilities and long term debt that does not exceed net current assets. For utilities debt should not exceed twice equity.
- Stable Earnings Some earnings for the last 10 years
- Uninterrupted Dividend record 20 years of dividend payment at least
- Growth of Earnings Minimum increase of at least one-third in per-share earnings over last ten years.
- Reasonable Price to Earnings Ratio Current price not more then 15 times average earnings past three years
- Reasonable Ratio of Price to Assets Current price not more then 1.5 times last book value. Graham also suggests that you multiply the P/E ratio by the price to book ratio and see whether the resulting nuymber is below 22.5
The criteria in this list is designed to eliminate losers and to preserve capital and keep you selecting individual securities which will have a margin of safety to withstand economic down turns.