Quick Reference - Graham and Serenity

Contents


"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 1½ 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 — or 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 1½ 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 4 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 also included criteria for earnings and diversification.

1. A diversified group of common stocks at a price less than the applicable net current assets alone — after deducting all prior claims, and counting as zero the fixed and other assets.
2. 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 all stocks, giving the following four results.

1. Intrinsic Value

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

a. Defensive

The Intrinsic Value is calculated from the quantitative criteria (#6 and #7) for Defensive investment, 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

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)

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.

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


2. 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), and has a positive Defensive Price (Graham Number).

b. Enterprising

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

c. NCAV (Net-Net)

The stock meets neither Defensive nor Enterprising criteria, but has a positive trailing 12 months (TTM) EPS and a positive NCAV Price (Net Current Asset Value / Net-Net).


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.


4. Graham Ratings

Each stock is additionally given the following Graham Ratings that can be used for customized filtering and stock selection. The ratings are defined such that Graham's Defensive requirements default to 100%.

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)
Size in Sales (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% N/A[1]
Dividend Record (100% ⇒ 20 Years) 100% 5% N/A
Earnings Growth (100% ⇒ 33% Growth) 100%[2] N/A[3] N/A
Graham Number(%)[4] 70%[5] N/A[6] N/A
NCAV or Net-Net(%)[7] N/A N/A 100%
[2 x Equity] ÷ Debt 100%[8] N/A N/A
Size in Assets (100% ⇒ 250 Million) 100%[8] N/A N/A

[1] Requires a positive TTM EPS, the sole data point that's not annual.
[2] 200% ⇒ 66% growth etc; years 0, 1, 2 and 9, 10, 11 used.
[3] The Trailing Annual EPS has to be more than that of 4 years ago.
[4] Graham Number ÷ Previous Close, similar to Intrinsic Value(%).
[5] 70% when adjusted for today's bond yields.
[6] Calculated using Trailing Annual EPS and Tangible Assets instead.
[7] NCAV Price ÷ Previous Close, similar to Intrinsic Value(%).
[8] Optional rating for Public-Utilities and Financial Enterprises.

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