Quick Reference - Graham and Serenity


"By far the best book about investing ever written... To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. This book precisely and clearly prescribes the proper framework."
Warren Buffett, in his preface to the 4th edition of Benjamin Graham's book, The Intelligent Investor.

Graham's Stock Grades

Graham recommended three categories of stocks, with different qualitative and quantitative specifications for each category.

1. Defensive

These were the highest quality (and costliest) stocks Graham recommended, and were required to have:

1. Not less than $100 million of annual sales.
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 ten 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 ten years using three-year averages at the beginning and end.
6. Current price should not be more than 15 times average earnings of the past three years.
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.
Benjamin Graham, Chapter 14: Stock Selection for the Defensive Investor, The Intelligent Investor

Criterion #1 works out to $500 million today, based on the difference in CPI/Inflation from 1971.

Graham recommended a minimum portfolio size of 10 for Defensive grade stocks; or in other words, not more than 10% of one's portfolio per Defensive grade stock.

2. Enterprising

For more Enterprising (or aggressive) investors, Graham recommended stocks "selling at multipliers under 10" that also had:

1-A. Current assets at least 11⁄2 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.
5. Price: Less than 120% net tangible assets.
Benjamin Graham, Chapter 15: Stock Selection for the Enterprising Investor, The Intelligent Investor

As these criteria were written in 1971, Serenity compares last year's earnings to that of 5 years ago for criterion #4.

Serenity recommends a minimum portfolio size of 20 for Enterprising grade stocks; or in other words, not more than 5% of one's portfolio per Enterprising grade stock.

3. NCAV (Net Current Asset Value or Net-Net)

Graham's most well known category of stocks, which also included criteria for earnings and diversification.

"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."
Benjamin Graham, Chapter 15: Stock Selection for the Enterprising Investor, The Intelligent Investor

Graham recommended a portfolio size of 30 for NCAV grade stocks; or in other words, not more than 3.3% of one's portfolio per NCAV grade stock.

Serenity's Assessment Results

Serenity applies all seventeen of the above Graham criteria to 5000+ U.S. stocks, giving each stock the following four results.

1. Graham Grade

Every stock is assigned a Graham Grade as follows.

a. Defensive

The stock meets the qualitative criteria for Defensive investment (#1 to #5 above), and has a positive Defensive Price (see Graham Number below).

b. Enterprising

The stock is not Defensive but meets the qualitative criteria for Enterprising investment (#1 to #4 above), and has a positive Enterprising Price (see Serenity Number below).

c. NCAV (Net-Net)

The stock meets neither Defensive nor Enterprising criteria, but has a positive EPS and a positive NCAV (see Net Current Asset Value below).

d. Ungraded

The stock meets none of the above conditions and thus no Graham Grade can be assigned.

2. Intrinsic Value

The Intrinsic Value for each Graham Grade is assigned as follows.

a. Defensive grade stocks

The Intrinsic Value is calculated from the quantitative criteria (#6 and #7) for Defensive investment given above, and is popularly known as the Graham Number.

Note: Graham Numbers on Serenity are calculated using the average EPS of the past three years, as Graham required.

b. Enterprising grade stocks

Graham's quantitative criteria for Enterprising investment are the lower of 120% of net tangible assets, or a P/E ratio of 10. With a derivation similar to the Graham Number, we get the following Intrinsic Value calculation.

c. NCAV (Net-Net) grade stocks

Graham recommended the applicable net current assets alone, deducting all prior claims, and counting as zero the fixed and other assets. The corresponding Intrinsic Value calculation is popularly known as Net Current Asset Value or NCAV.

d. Ungraded stocks

Ungraded stocks are assigned an Intrinsic Value of Zero. Stocks are also assigned an Intrinsic Value of Zero if their calculated prices according to their respective Graham Grades are nonpositive.

Note: Serenity does not use the misunderstood Benjamin Graham Formula to calculate intrinsic values.

3. Intrinsic Value(%)

Intrinsic Value ÷ Previous Close, expressed as a percentage. An Intrinsic Value(%) of 100% or more indicates that the stock's Intrinsic Value exceeds its price.

Graham Grade, Intrinsic Value and Intrinsic Value(%) — in combination — give a complete Graham assessment for a stock. Value Investing 101 provides a list of standard preloads that can be quickly applied to Serenity's stock screeners.

Completely Defensive and Enterprising grade stocks require an Intrinsic Value of 70% or higher at today's bond yields.

Stocks with an Intrinsic Value of Zero (or hypothetically, a Previous Close of Zero) are assigned an Intrinsic Value(%) of 0.00%. All Ungraded stocks therefore have an Intrinsic Value(%) of 0.00%.

Note: Graham's framework is designed for building a complete portfolio, and not for picking individual stocks.

4. Graham Ratings

Each stock is additionally given the following Graham Ratings that can be used for customized filtering and stock selection. For reference, the minimum ratings required for each of Graham's grades are given below.

This list scrolls horizontally on smaller screens.
Graham Rating Minimum Values
Defensive Enterprising NCAV (Net-Net)
Sales or Size (100% ⇒ $500 Million) 100% N/A N/A
Current Assets ÷ [2 x Current Liabilities] 100% 75% N/A
Net Current Assets ÷ Long Term Debt 100% 90% N/A
Earnings Stability (100% ⇒ 10 Years) 100% 50% 10%
Dividend Record (100% ⇒ 20 Years) 100% 5% N/A
Earnings Growth (100% ⇒ 33% Growth) 100%[1] N/A[2] N/A
Graham Number(%)[3] 70% N/A[4] N/A
Equity ÷ Debt (for Utilities and Financials)[5] N/A N/A N/A
NCAV or Net-Net(%)[6] N/A N/A 100%

[1] 100% ⇒ 33% growth, 200% ⇒ 66% growth etc; read more.
[2] The current EPS has to be more than that of 5 years ago.
[3] Graham Number ÷ Previous Close, similar to Intrinsic Value(%).
[4] Calculated using Trailing EPS and Tangible Assets instead.
[5] Optional rating for Public-Utilities and Financial Enterprises.
[6] NCAV Price ÷ Previous Close, similar to Intrinsic Value(%).