What are Graham's stock selection criteria for defensive investors?

Hey, talking about Graham's stock selection advice for us regular folks (which he termed "defensive investors"), this is a classic topic. The core idea from the old master is "safety first"—don't muck about, buy solid, cheap, good companies.

Specifically, he laid out 7 golden criteria. Let me break them down for you one by one:

1. Adequate Size

Simply put: Don't buy those small companies you've never heard of.
Why? Large companies are like large ships on the ocean, small companies like little boats. When storms hit (economic crises, industry turmoil), the big ships are steadier and less likely to capsize. Big companies usually have more diversified businesses, stronger financial resources, and much better ability to withstand risk. Graham gave specific sales or asset size standards back then, but that number is irrelevant now. You just need to understand that you should choose the top industry leaders—like those big brands you see and use regularly in daily life.

2. Sufficiently Strong Financial Condition

Simply put: The company must have enough cash in its pocket and not be weighed down by too much debt.
How to tell? Graham gave two hard rules:
- Current Ratio of at least 2: This means the company's "current assets" (cash it can get within a year) must be at least double its "current liabilities" (debts due within a year). It's like having $200 in ready cash in your wallet, while your credit card bill due next month is only $100 – you feel secure without short-term cash pressure.
- Long-term debt must not exceed net current assets: Net current assets are the "current assets" minus the "current liabilities" mentioned above. This rule means the company shouldn't be operating loaded with long-term debt. A company growing through its own earnings rather than borrowing is clearly healthier.

3. Earnings Stability

Simply put: The company must have made a profit every single year for the past 10 years.
Why? If a company can maintain profitability consistently for ten years, even through good and bad economic cycles, it strongly proves there's sustained demand for its products or services and its business model is solid. It's like a student: doing well once might be luck, but passing every exam for ten years straight means they definitely know their stuff.

4. Dividend Record

Simply put: The company must have a long track record of consistently paying dividends to shareholders.
Why? Profits on financial statements can sometimes be "paper wealth," but dividends are real cash in hand. A company willing and able to consistently pay dividends for many consecutive years (Graham suggested 20!) signals two things: First, its cash flow is very healthy; Second, management respects shareholders and is willing to share the business's success.

5. Earnings Growth

Simply put: The company shouldn't just stand still; it needs to show some progress.
How to tell? Graham's standard requires that, looking at the past ten years' data, earnings per share should increase by at least one-third. To avoid anomalies in any single year, he suggested comparing the average of the first three years to the average of the last three years. This ensures you aren't buying a company that's stable but completely stagnant—a "zombie company." It needs to be a dynamic company that's slowly getting better.

6. Moderate P/E Ratio

Simply put: The price you pay shouldn't be too expensive.
How to tell? The Price-to-Earnings (P/E) ratio is the price you pay for each $1 of the company's annual profit. Graham advised that the P/E ratio should not exceed 15. This number acts like a "price ceiling," helping you filter out stocks that have become overheated by market hype. Buying cheap is a form of safety in itself.

7. Moderate Price-to-Book Ratio

Simply put: The stock price shouldn't be too expensive relative to the company's "all its worth."
How to tell? The Price-to-Book (P/B) ratio is the price you pay for each $1 of the company's net assets (all its assets minus all its liabilities). Graham suggested that the P/B ratio should not exceed 1.5.
Super Combination: Graham also gave a more sophisticated "double safety net" criterion: P/E ratio × P/B ratio < 22.5. This formula is very clever as it allows flexibility. For example, if a company has a low P/E (say, only 10), then a slightly higher P/B (say, 2.2) could be acceptable. Vice versa. This helps you find bargain stocks that the market has mistakenly undervalued in one way or another.

To Summarize

Think of Graham's set of criteria as a "dating" process:

Adequate Size: Solid background, comes from a reputable family.
Strong Financial Condition: Not overburdened with debt, has its own savings.
Earnings Stability: Has had stable employment over the past decade, earning an income every year.
Dividend Record: Good character, willing to share earnings with family.
Earnings Growth: Ambitious, career steadily progressing.
Reasonable Price (P/E, P/B): Doesn't ask for an excessive "dowry," offers great value for money.

In a nutshell, this set of standards Graham gave defensive investors acts like a dual "security gate" for quality and price. The core ideas are just two words: Solid and Cheap. Companies meeting all these conditions are rare, but that's precisely why they're worth hunting for.

Hope this explanation helps!