The Intelligent Investor-Benjamin Grahams approach
Margin of safety – According to Graham, margin of safety means buying companies that are cheap relative to their intrinsic worth, or what the company would be worth if the entire business were sold. If the company cannot effect a turnaround, you can cut your losses with less damage.
Buy large companies with strong sales figures – Graham felt that if a company had at least $100 million in revenues (in the 1930s), it had a better chance of surviving. His rationale was that tiny companies have a harder time cushioning the blows of an economic downturn, so it’s best to invest in larger companies.
Go for companies that pay dividends regularly – Graham believed that investors must consider companies that have paid a dividend every year for at least 20 years. Not only are dividends a sign that a company is profitable, but they also offer investors a return even if the company’s stock is performing poorly.
Choose companies that are in financially sound – Graham looked for companies whose current assets exceed the sum of current and long-term debt. He was always mindful of liquidity. His thinking was that companies with ample liquidity (access to cash) were less risky because their assets could always be sold to raise cash.
Find companies with sustainable earnings growth – Graham always sought companies with an upward earnings trend, but profits didn’t necessarily have to rise every year. They just couldn’t be regressing. He felt that steadily improving earnings would lead to improving stock performance.
Pay attention to price multiples – Graham searched for companies with price/earnings ratios below their historical average. Moreover, he wouldn’t buy a stock unless it was trading for less than 1.2 times its book value per share (BV = assets minus liabilities).
In today’s world, it may be difficult to find stocks that satisfy all of Graham’s investment criteria, but they do serve as a useful guideline to investors who are venturing into the stock market for the first time.