Description

The Enterprising Investor stock screen was made popular by Benjamin Graham’s book The Intelligent Investor. In the book, Graham identifies two categories of investors; the defensive and the enterprising. According to Graham, an enterprising investor buys from a list of common stocks “that can be identified as undervalued by logical and reasonably dependable standards.” Here, we display such a list based on the requirements spelled out by Graham.

Chapter 15 of The Intelligent Investor is titled “Stock Selection for the Enterprising Investor.” In this chapter Benjamin Graham lays out six criteria which are “rather similar to those we suggested for the defensive investor, but not so severe.” The first criteria is concerned with the stock’s price relative to recent earnings, and the next four are concerned with the company’s “past performance and current financial position,” The last requirement values the stock based on the company’s net tangible assets.

Core Criteria

The five qualifying characteristics an Enterprising Investor stock must have in order to be considered for purchase are: low price to earnings, financial stability, consistent profitability, dividend payments, and increased earnings.

• Graham states that a low price in relation to recent earnings is a prima facie indication that a stock is cheap. He says a P/E ratio under 10 makes a “goodly number of candidates for further selectivity.” Therefore, the first criteria of the Enterprising Investor stock screen is a trailing P/E ratio of less than 10.
• In an attempt to ensure only financially strong companies are considered, Graham wanted companies with current assets at least one and a half times as high as current liabilities AND long-term debt no more than 110% of net current assets. We filter for companies with a current ratio greater than 1.5 and maximum levels of long-term debt no more than 110% of the difference between current assets less current liabilities.
• To identify consistently profitable companies, Graham looked for companies which reported positive earnings in each of the last 5 years. We follow Graham’s requirement and eliminate any company with negative earnings in the last 5 years.
• For Graham, cash dividends were a sign that management “thought like owners” and was concerned with increasing shareholder value. For this screen, he recommended any stock that is currently paying a dividend. We include any stock that has paid a dividend in the trailing twelve months.
• It was important to Graham that an Enterprising Investor look for companies which have experienced some growth in recent years. To find these companies, Graham suggested companies whose most recent reported annual earnings were greater than the annual earning 5 years prior. We modify this guideline slightly and only include stocks with a positive 5-year net income CAGR (compounded annual growth rate) when screening for Enterprising Investor stocks.

Valuation Factors

The above criteria considerably narrows the field of investable stocks for an Enterprising Investor. Just because a company meets all those requirements, does not necessarily mean it is a good investment. Whether or not a good business is a good investment depends on the price paid. We already guarantee all stocks for this screen have tremendously low P/E ratios, but that is not factored into calculating the intrinsic value.

To find the intrinsic value, the Enterprising Investor screen measures a stock’s tangible assets. Graham said the price paid should be less than 120% of the company’s net tangible assets. To find this amount, we simply subtract goodwill and intangibles from the company’s book equity and divide by the total number of diluted shares. For example, a company with $10 billion in book equity, $2 billion in goodwill, and $1 billion in other intangibles with 200 million diluted shares outstanding would have an intrinsic value of $42/share:

• $10,000,000,000 – ($2,000,000,000 + $1,000,000,000) = $7,000,000,000
• $7,000,000,000 / 200,000,000 shares = $35/share
• $35 * 1.2 = $42

Results

The top 25 stocks which meet all the “core criteria” are listed in order of lowest price to intrinsic value (sorted top left to bottom right).

Implementation

Graham states that the enterprising investor strategy finds companies “that are making a good showing, have a satisfactory past record, but appear to hold no charm for the public.” He says a group of these stocks “should offer good promise of satisfactory investment results.” Obtaining this group can be accomplished by regularly investing equal amounts in the qualifying stock with the lowest price in relation to intrinsic value.