How To Build A Complete Benjamin Graham Portfolio

Benjamin Graham was an economist and professional investor who taught Warren Buffett, Irving Kahn, Walter J. Schloss and other famous investors at Columbia Business School.

Buffett, who credits Graham with grounding him with a sound intellectual investment framework, describes Graham as the second most influential person in his life after his own father. In fact, Graham had such an overwhelming influence on his students that two of them, Buffett and Kahn, named their sons after him.

In the preface to Graham's book, The Intelligent Investor, Buffett calls it "by far the best book about investing ever written."

Greater Effort, Greater Returns

Contrary to common thinking that greater profits require greater risks, Graham said that if he had to distill the secret of sound investment into three words, they would be "Margin of Safety." The chapter on "Margin of Safety" in Graham's book is also the one most highly recommended by Buffett.

Graham taught that the returns an investor could expect were not proportional to the risk he was willing to assume, but rather, to the effort he was willing to put into his investments. He thus recommended various investing strategies that offered differing returns, and required varying degrees of the diligence.

In this article, we will look at each of these strategies in turn, and see how one can implement them today.

Strategy 1: Zero Effort - Index Funds

Graham often emphasized that most mutual funds did not beat the market average, as measured by the indices. He thus recommended that the first strategy for any investor -- one that required nearly no effort -- was to proportionally invest in stocks listed in the indices. This is something that can be done a lot more easily today, by simply investing in an index fund.

Quoted from Chapter 14 of The Intelligent Investor - Stock Selection for the Defensive Investor:

"In setting up this diversified list he has a choice of two approaches, the DJIA-type of portfolio and the quantitatively- tested portfolio. In the first he acquires a true cross-section sample of the leading issues....[shortened]... This could be done, most simply perhaps, by buying the same amounts of all thirty of the issues in the Dow-Jones Industrial Average."

Thus it would be safe to say that Graham's first recommended strategy today would be to invest in a reputed index fund following a popular index like the DIJA or the S&P 500. Graham believed that the choice of index would make very little difference.

General research on fund performance seems to indicate that the S&P 500 Index Funds rate the highest, especially against managed mutual funds (as expected). Some of the best performing S&P 500 Index Funds appear to be those by Vanguard [VFINX], Fidelity [FUSEX] and Schwab [SWPPX].

However, there are numerous resources available online specifically for the purpose of analyzing index funds. So we shall move on to the more complex, and more profitable, of Graham's strategies -- the ones concerning the selection of stocks.

Strategy 2: Minimum Effort - Defensive Grade Stocks

The first grade of stocks recommended by Graham are called Defensive stocks. The criteria that Graham specified for identifying Defensive stocks are as follows:

Summarized from Chapter 14 of The Intelligent Investor - Stock Selection for the Defensive Investor:

1. Not less than $100 million of annual sales.
[Note: This works out to $500 million today based on the difference in CPI/Inflation from 1973]
2-A. Current assets should be at least twice current liabilities.
2-B. Long-term debt should not exceed the net current assets.
3. Some earnings for the common stock in each of the past 10 years.
4. Uninterrupted [dividend] payments for at least the past 20 years.
5. A minimum increase of at least one-third in per-share earnings in the past 10 years.
6. Current price should not be more than 15 times average earnings.
7. Current price should not be more than 1-1⁄2 times the book value.
As a rule of thumb, we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5.

Graham's recommended price for Defensive stocks can be calculated from criteria #6 and #7 as the square root of (22.5 x EPS x BVPS). This price is popularly known as the Graham number.

Graham recommended a minimum portfolio size of 10 and a maximum of 30 for defensive investors. Since Defensive stocks are the most well established stocks meeting the most stringent of criteria, the effort required to create and maintain the portfolio can be reduced to a minimum by restricting the portfolio to 10 Defensive stocks.

A full Graham analysis of all 4000 NYSE and NASDAQ stocks brings up 12 stocks meeting all of Graham's defensive criteria, even with calculations adjusted for inflation. Shown here are the first 10 from the Classic Graham Screener (image captured in 2012):


Latest Defensive Stocks

The following links will open Serenity's Graham stock screeners preloaded with stocks that clear Graham's rules for Defensive Industrials today.

The following link will open the Advanced screener preloaded with stocks that clear Graham's rules for Defensive Financials today.

All Defensive Financials

Graham Analysis Example - BHI

To better understand how this result was arrived at, let us look at the detailed analysis for the first of these stocks - Baker Hughes Inc. (BHI).

The first section on BHI's page gives some useful financial ratios. But this information is not directly required for the actual Graham analysis.

The next section is of more interest since it gives an individual rating for each of the eight Defensive criteria specified by Graham. As can be seen, BHI scores more than 100% on all ratings, as is required for an approved Defensive stock.

But the most important section is the last one. This section gives all the three different Graham prices for a stock, and then gives the final Graham analysis for the stock. In the case of BHI, it shows that BHI is a Defensive stock, and hence BHI's final Graham price is the same as its Graham Number. Finally, this section shows that the current price of this stock is less than its Graham price, so the stock is approved for purchase.

Strategy 3: Medium Effort - Enterprising Grade Stocks

For Enterprising investors who are looking for greater profits, and are willing to put in more effort into the maintenance of their portfolio, Graham then recommends the following criteria for identifying Enterprising grade stocks:

Summarized from Chapter 15 of The Intelligent Investor - Stock Selection for the Enterprising Investor:

[Note: For issues selling at P/E multipliers under 10]
1-A. Current assets at least 1 1⁄2 times current liabilities.
1-B. Debt not more than 110% of net current assets.
2. Earnings stability: No deficit in the last five years covered in the Stock Guide.
3. Dividend record: Some current dividend.
4. Earnings growth: Last year's earnings more than those of 1966.
[Note: This corresponds approximately to the earnings of 2007 today]
5. Price: Less than 120% net tangible assets.

This second set of criteria gives us a Graham price for a stock meeting Enterprising conditions as the lower of 120% net tangible assets (book value), or 10 times current earnings. We can combine the two - as Graham did for the Defensive Price - to yield a price calculation similar to the Graham Number. Let's call this the Serenity Number.

Since Enterprising stocks are not as well established as Defensive stocks, the portfolio needs to be diversified more. Serenity's recommendation is for a minimum of 20 Enterprising stocks. Such a portfolio will also require more effort in the selection, verification, tracking and balancing of the component stocks.

An automated analysis of all 4000 NYSE and NASDAQ stocks brings up 25 stocks meeting all of Graham's enterprising criteria, with calculations adjusted for inflation. Shown here are the first 10 from the Classic Graham Screener (image captured in 2012):


Latest Enterprising Stocks

The following links will open the screeners preloaded with stocks that clear Graham's rules for Enterprising investors today.

Strategy 4: Maximum Effort - NCAV Grade Stocks

For investors who were willing to put in the most effort into the maintenance of their portfolio, Graham finally recommended NCAV grade stocks, which he defined as:

Summarized from Chapter 15 of The Intelligent Investor - Stock Selection for the Enterprising Investor:

"Bargain Issues, or Net-Current-Asset Stocks"
"...price less than the applicable net current assets alone - after deducting all prior claims, and counting as zero the fixed and other assets."
"...eliminated those which had reported net losses in the last 12-month period."

These criteria give us stocks selling for less than the value of their cash worth alone, and with positive earnings in the last one year. These stocks are also the most famous of Graham's stocks, and the source of the general misconception that Graham only recommended cheap stocks. These were, in fact, the last grade of stocks that Graham recommended.

Since NCAV stocks are the least established stocks of all stocks, such a portfolio will have to be the most diversified, requiring at least 30 NCAV stocks. Such a portfolio will also require the most effort in the selection, verification, tracking and balancing of its component stocks.

An automated analysis of all 4000 NYSE and NASDAQ stocks brings up more than 300 stocks meeting all of Graham's NCAV criteria, with calculations adjusted for inflation. Shown here are the first 10 from the Classic Graham Screener (image captured in 2012):


Latest NCAV Stocks

The following links will open the screeners preloaded with stocks that clear Graham's NCAV rules today.

Strategy 5: Special Situations or "Workouts"

Graham considered Special Situations theoretically a part of the program of operations of an Enterprising investor, but classified them as a business altogether different from regular investing.

As the name indicates, these are special strategies that follow no specific rules or calculations. Some of the operations that Graham classified under this category are acquisitions of smaller firms by larger ones, arbitrage operations, the breakup of public-utility holding companies pursuant to legislation, issues that are involved in any sort of complicated legal proceedings and with prices beaten down to unduly low levels due to the ensuing prejudice, etc.

Being able to identify and take advantage of a special situation requires years of experience with Graham's previous strategies. Graham himself wrote:

"The exploitation of special situations is a technical branch of investment which requires a somewhat unusual mentality and equipment. Probably only a small percentage of our enterprising investors are likely to engage in it..."

And elsewhere, he noted about "workout or arbitrage" opportunities:

"This has become more than ever a field for professionals, with the requisite experience and judgment..."

Thus, special situations will need to be studied on a case by case basis and are not open to any general analysis. But any investment of this kind will still need to meet Graham's basic requirements of a "Margin of Safety," as well as his definition of an investment operation (as distinguished from speculation).

"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

Checking For Splits

When using strategies #2, #3 and #4 -- after the investor has shortlisted his preferred combination of Defensive, Enterprising and NCAV grade stocks -- the next most important step is to verify the stocks for any recent splits. The Book Value and EPS data for a stock that has just been split are not usually publicly disseminated until the next financial cycle. Thus, while the market price will already reflect the reduced split price, the public financial data for the stock might still wrongly indicate the previous higher Graham price.

Only once it is clear that the selected stocks have not been split since they last announced their financial results -- and do, in fact, meet Graham's criteria for investment -- do we proceed to the final steps, which are to quickly verify the data used for analyzing the stocks and place the required orders.

To Conclude

The effort Graham foresaw in investing was not only in finding and verifying stocks, but also in monitoring and balancing the portfolio -- selling stocks that have corrected themselves and buying new ones etc. Thus, the more stocks in your portfolio, the greater is the overall effort involved.

So it important to choose an investment strategy carefully. A good approach would be to start with a low effort strategy and evolve as you get more comfortable; possibly starting with 10 defensive stocks, and gradually replacing five of them for 10 Enterprising ones and so on.

Graham's principles have been recommended again and again over the years -- by Buffett and by Graham's other students -- in books and in speeches. Buffett even gave a famous speech in 1984, called "The Superinvestors of Graham-and-Doddsville" about why the most successful investors in the world were all students of Graham.


Excellent summary of the Benjamin Graham investment method. I first read this book about 40 years ago. This is the first attempt I have seen at using modern methods to ferret out Graham stocks. Thank you Serenity!

Thank you, Northewest Bob.

It's a pleasure having you on Serenity!

If you have any doubts on using the screeners, please feel free to ask in the forums or contact Support directly.

Serenity Readers: I sent the following questions to Serenity regarding this article and they were kind enough to provide an informative response. They asked that I post my question and their response in the comment section, so below is our correspondence. We hope you find it helpful.


Hi - I just read your great article on SA today and would like to follow the practices that Graham recommends. I have ordered his book and will read it as soon as it arrives. In the meantime, I am identifying a group of stocks that I want to build into a personal protfolio. I understand the selection criteria and the need to make additional verifications once a stock has been identified prior to investing. However, I have a couple of questions regarding the process once the portfolio has been built.

1) Assuming that dividends are being reinvested, what criteria is used to "rebalance" the portfolio? I would assume some percentage allocation, but is there more to it?

2) Under what circumstances would you sell a stock that has been bought using the selection criteria? I assume (perhaps incorrectly) that the stocks are reassessed (screened) each quarter after the financial reports are released to make sure they still meet the criteria. Would you sell a stock the first time it fails to meet the screening criteria? Would you then reinvest that cash into another stock that better meets the criteria? This would seem to nullify the "buy and hold" principle.

I'm considering building the portfolio consisting of 50% Enterprising, 30% Defensive and 10% Cash. I don't intend to draw from this portfolio (IRA) for 10 years.

I'd be interested in your thoughts on these and any other areas you think I might want to consider.

Thanks in advance for your thoughts and I look forward to using your site extensively in the future.

Serenity response:

Thank you again for your interest in Serenity!
Sorry for the delay in replying but the answers to your queries required detailed references.

You already seem to have a very good understanding of the article.

You have also made a great decision by buying The Intelligent Investor.
Even though Serenity provides the tools and guidelines for implementing Graham's instructions today, the book itself comes with invaluable advice on investing as a whole. That's why Buffett calls it "by far the best book about investing ever written".

From "CHAPTER 5: The Defensive Investor and Common Stocks"
"Presumably our defensive investor should obtain—at least once a year—the same kind of advice regarding changes in his portfolio as he sought when his funds were first committed"
"Incidentally, if his list has been competently selected in the first instance, there should be no need for frequent or numerous changes."

From "CHAPTER 8: The Investor and Market Fluctuations" (the highest recommended chapter by Buffett, along with "Margin of Safety")
"There are two chief morals to this story. The first is that the stock market often goes far wrong, and sometimes an alert and courageous investor can take advantage of its patent errors. The other is that most businesses change in character and quality over the years, sometimes for the better, perhaps more often for the worse. The investor need not watch his companies’ performance like a hawk; but he should give it a good, hard look from time to time."
"Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies."
"the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage."
"The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices."

Thus, Serenity's recommendations for your queries are as follows:

1. Rebalance your portfolio once a year, but as little as possible - either by reinvesting dividends and other income, or by rearranging the stocks themselves.
Maintain a fixed percentage of your investments in each eligible stock - not exceeding 10% in each Defensive grade stock, 5% in each Enterprising grade stock or 3% in each NCAV stock.

2. Buffett has said his "favorite holding period is forever". But that does not mean he holds all his investments forever. There are also practical limitations to regularly turning over a portfolio the size of Buffett's.
But for regular investors, one of the greatest advantages stocks offer over other instruments - in addition to the highest average returns - is their liquidity. So do sell stocks that have overshot their Graham price, and invest in other eligible ones.
Rebalancing your portfolio a little once a year does not violate the "acquire and hold" principle Graham mentions above. You will not be relying blindly on price movements for your profits, but rather on the stock's inherent business performance - and the resulting market corrections.

Buffett once said "Lethargy, bordering on sloth should remain the cornerstone of an investment style."
No one could have put it better.
Manage your portfolio as you would manage any other large investment, by buying it carefully and then keeping it for as long as there is nothing better to invest in.

Thank you so much, kcourten.

It was very kind of you to post Serenity's reply as well.
Please feel free to contact Support anytime if you have any other questions.

Again, it's a pleasure having you on Serenity!

Hello kcourten,

Here is a detailed post on Graham's recommendations on selling stocks.
He addresses Defensive stocks specifically in one of the recommendations.

Serenity Support

Great article Serenity, by the way is there a similar study for ETF's?

Thank you for posting your comment here, rusoloco!

Serenity specializes in stocks. An online search doesn't bring up any quantitative study of ETFs with a similar level of detail by anyone else.
Sorry for not being able to help you on this.

But if you have the Book Value and EPS for an index or a fund, you can derive its Graham Number and Enterprising Price.
For example, here's a partial Graham analysis for the S&P 500.

In fact, if you have all the required data, you can do a complete Graham analysis for an index or a fund too.
But on the whole, it seems easier to find all the required data for a stock.

Thanks for writing this article and sharing your site! Definitely thought provoking. I will be doing research using your site in the next few weeks.

Thank you for posting your comment here, Mike!

Glad to be of help.

If you have any doubts on using the screeners, please feel free to ask in the forums or contact Support directly.

"Thanks Serenity for another great article and your service. I am especially grateful you folks do all these hard calculations. I do not have a background in finance and accounting, but am slowly educating myself. I refer to the classic text often, but find it somewhat intimidating at times. Thanks too for coaching us on the best ways to think about using the results of the analysis. I have started off with the low effort approach, and use it to confirm the recommendations of my full service broker. I know there will be critics of full service brokers, but my wife and I are in our maximum earnings years with busy careers, and frankly don't have this kind of time. Thanks again for your service, and I am a regular follower of your articles and website. Best wishes for much success!!"

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