In the 14th chapter of “The Intelligent Investor,” Benjamin Graham drills deeper to discuss how defensive investors can or should select stocks; in chapter 15 he will do the same for enterprising investors.
He refers to this as the “broader applications of the techniques of security analysis.” Graham promises those who follow his suggestions will buy only high-grade bonds and a diversified group of leading stocks.
To create this list of stocks, defensive investors will take one of two approaches:
A Dow Jones Industrial Average-type of portfolio. A “quantitatively-test-portfolio.”
The DJIA-type portfolio would have been created by buying the same number of shares in each of the 30 stocks that comprised it. Now, we would simply buy an index mutual fund or exchange-traded fund, but those were not so commonly available when Graham published the final edition of his book in 1973. Graham refers to investment funds, but it is helpful to recall the first real index fund was introduced by John Bogle in 1975. In buying all companies in the Dow Jones, investors would get a cross-section and some diversification.
Graham‘s analysis from this point forward is based on the prominent categories of his time, but the lessons he teaches in each of these categories continue to be relevant.
Assessing industrial stocks
Turning to the “quantitatively-test-portfolio,” Graham says this would apply a group of standards to each purchase:
A “minimum of quality,” as demonstrated by past performance and a company’s current financial position. A “minimum of quantity,” based on earnings and assets per dollar of price.
These are his quality and quantity criteria:
Adequate size: In 1973 he was arguing for at least $100 million in annual sales for an industrial company (which dominated the markets in his day; tech stocks were still more than a decade away), or $50