What type of stocks does Benjamin Graham recommend for defensive investors?
Hey friend! Talking about Graham's advice for us ordinary investors (whom he called "defensive investors"), this is a classic topic. His core idea is actually quite simple: don't lose money, don't overpay. He doesn't advocate chasing after speculative, overheated stocks that are soaring. Instead, think of it like shopping in a farmer's market – pick stocks that are solid, high quality, and reasonably priced.
So, the stocks he advises defensive investors to buy aren't tied to a specific industry but represent a category of "good companies" that meet his strict criteria. You can think of it as a shopping list – only items meeting the following conditions get into your cart:
The "Seven Principles" for Defensive Investors' Stock Selection
Graham provides a very specific, actionable checklist to help us screen stocks.
1. Strong Company Size (The Big Guys)
He believed we should invest in large, significant players within their industries. Why? Because major companies typically have stable operations, substantial resources, and greater resilience. They are less likely to be upended by minor disruptions. Think of a durable aircraft carrier – far more stable in rough seas than a small kayak.
2. Strong Financial Health (The Pocketbook Check)
This is crucial. Simply put, the company should have significantly more "ready cash" (current assets) than its short-term debts (current liabilities). Graham's standard is a current ratio of at least 2 (meaning current assets are twice current liabilities). Long-term debt should also not be excessive. This ensures healthy cash flow and prevents the company from getting into trouble due to cash shortages.
3. Long-term Profitability (A Consistent Earner)
Graham demands that the company must have earned a profit in each of the past ten consecutive years. He doesn't require soaring profits every year, but there absolutely cannot be any years of losses. It's like choosing a friend with a stable job – it shows the company is run soundly and is trustworthy.
4. Consistent Dividend Payments (Willing to Share the Profits)
He requires the company to have a continuous record of paying dividends for at least the last twenty consecutive years. A company that consistently pays dividends demonstrates two key things:
- It generates genuine, sufficient cash flow.
- Management respects shareholders and is willing to share the profits.
5. Modest Earnings Growth (Not Standing Still)
Even for defensive investing, you shouldn't buy into a company in decline. Graham requires earnings per share (EPS) to have increased by at least one-third over the past ten years. This isn't a high bar, but it ensures the company you're buying is progressing steadily, albeit slowly, rather than regressing.
6. Modest Price Relative to Earnings (The Price Tag Check - P/E Ratio)
This is the core of value investing! Even a great company isn't a good buy if you pay too much. Graham's guideline is that the current stock price should not exceed fifteen times the average earnings per share (EPS) over the past three years. The Price-to-Earnings ratio (P/E) can be roughly understood as "how many years would it take, based on current profits, for the company to earn back the price you paid." A high number suggests the stock might be overvalued.
7. Modest Price Relative to Asset Value (The Price Tag Check - P/B Ratio)
Besides profitability, consider the company's "net worth" (book value/assets). He suggests the stock price should not exceed 1.5 times the company's book value (net asset value) per share.
Graham's Clever Filter: To prevent being too lenient on any single standard, he proposed a composite checkpoint: P/E Ratio × P/B Ratio < 22.5. This formula helps quickly filter out stocks that might be overpriced based on one metric alone.
To Sum It Up
Therefore, Graham's ideal profile for a defensive investor's stock is:
A large, financially robust company, consistently profitable over the long term, continuously paying dividends, showing steady growth, and currently trading at a very reasonable or even cheap price.
It's worth noting that in today's market, finding a company that perfectly fits all these demanding criteria might be challenging. However, the underlying principle never goes out of style: Don't risk your hard-earned money on companies you don't understand, that are overpriced, or have weak financials. Buy solid, well-run companies at a safe price, and then hold them patiently like a farmer awaiting harvest.
This is the most valuable investment wisdom Graham offered to ordinary people.