We've discussed in the past some of the more familiar value/bargain screening criteria that can be derived from Benjamin Graham's earlier work, e.g the NCAV and Enterprising Investor Screens.

What may be less known to you, though, is some quantitative work that Graham did towards just before his death (known as his "Last Will") with the help of a aeronautical engineeer James Rea, where he first identified the 10 best-performing stock selection criteria and then apparently distilled them into the 3 most important criteria.

Background

It seems that, upon reading an article that Graham had written for Barron's—“Renaissance of Value"— Rea forwarded some of his quantitative/screening research to Graham. This led to a three-year working relationship before Graham died, which culminated in two articles, one by Rea and one by Blustein (for Forbes) where they set out the findings of the research based on 50 years of back-testing as to the most effective value screening criteria for the US market.

Benjamin Graham's 10 Rules for Stock Selection

Here's the list that Graham came up with. The idea behind the rules is that the first five measure "reward" (by pinpointing a low price in relation to key operating results like earnings) and the second five "risk" (by measuring financial soundness and stability of earnings).

  1. An earnings-to-price yield at least twice the AAA bond rate
  2. P/E ratio less than 40% of the highest P/E ratio the stock had over the past 5 years
  3. Dividend yield of at least 2/3 the AAA bond yield
  4. Stock price below 2/3 of tangible book value per share
  5. Stock price below 2/3 of Net Current Asset Value
  6. Total debt less than book value
  7. Current ratio great than 2
  8. Total debt less than 2 times Net Current Asset Value
  9. Earnings growth of prior 10 years at least at a 7% annual compound rate
  10. Stability of growth of earnings in that no more than 2 declines of 5% or more in year end earnings in the prior ten years are permissible.

Unfortunately, the issue with these criteria is that, if all 10 are used, the criteria are just too onerous and are unlikely to result in a meaningful number of picks, especially with changing market conditions and business practices over time. The question which Graham and Rea explored is whether certain criteria can be preferred over others?

Unlock the rest of this article with a 14 day trial

Unlock with Email
Unlock with Google

Already have an account?
Login here