Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Markets: Rules for defensive investors - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Mar 16, 2004

    Markets: Rules for defensive investors

    In his classic, 'The Intelligent Investor', Benjamin Graham defined an investment as one, which upon thorough analysis promises safety of principal and an adequate return. Further, according to him, operations not meeting these requirements are deemed speculative in nature. Graham also differentiated between two types of investors - aggressive and defensive. The former, according to him is one who is enterprising and is willing to devote time to his stock selection. Such an investor would carefully select securities that are both sound and relatively more attractive than the average.

    On the other hand, a defensive investor, according to Graham, is one who places high emphasis on avoiding serious mistakes or losses. Also, a defensive investor would aim at freedom from effort and the need for making frequent decisions. In this article, we would concentrate our efforts on defining the rules to be followed by a defensive investor while making his investment decision, keeping those for an aggressive investor for later times.

    As mentioned earlier, a defensive investor should keep some benchmarks for himself while selecting his portfolio of stocks. Only this would be of help in his need for making less frequent decisions. However, this does not mean that a defensive investor should pick up stocks without considering his risk-return profile. For such kind of an investor, Graham outlined certain rules to be followed before taking any investment decision. In fact, these are some of the characteristics that a defensive investor should look at in a company.

    Adequate size of the enterprise: Graham considers is one amongst the most important factors. This is because small companies or those that are in the nascent stages of their development are more likely to have a volatile future than bigger corporations. While an aggressive investor would have interest in such small yet growing companies, this should not be a defensive investor's cup of tea. He should be happy in having large and strong companies in his portfolio.

    A sufficiently strong financial condition: Graham gives top priority to a sufficiently strong financial condition of a company. Investors should make sure that their investment target (company) has a strong balance sheet and profit and loss account, and a very strong cash flow statement. This is because, more than book profits, it is the strong cash position that is of help for the company in times of pressure and uncertainty. Specifically, Graham states that a manufacturing enterprise's current assets should be at least twice its current liabilities. This is to say that the current ratio should be at least 2. Also, for such companies, long-term debt should be less than the net current assets (or working capital).

    Earnings growth and stability: For a company to be a sound investment target, not only should it have a history of decent earnings growth, but also stability in the same. A company with a volatile earnings growth history is more likely to be a risky proposition. By this, Graham probably means earnings after paying interest on debt, or what is left for equity investors.

    Dividend growth: Regular dividend payments and consistent growth in payout (Dividends upon Earnings) is another indicator of the sound financial position of the company. While there might be instances when a growing company is ploughing back earnings towards future growth rather than paying large dividends, but investors must see that there are no grave inconsistencies in dividend payments.

    Moderate P/E ratio: A moderate Price-to-Earnings ratio is a very useful indicator for a defensive investor. This is because a relative lower P/E would save investors from paying a very high price that does not justify the value of an investment. Also, a history of moderate or less-volatile P/E's also helps the investors' cause. This is because a company that has had volatile P/E's in the past is a case of investors building up 'irrational expectations' of its growth.

    While Graham does not specifically mention about 'management quality' as an indicator for defensive investors, we believe that the presence of the abovementioned characteristics in a stock is in itself an indicator of a strong management. All said and done, while the rules mentioned above are benchmarks that every defensive investor needs to apply before making any investment decision, the fact that he should do his homework carefully should not lose relevance. This means that he should research well about the company's history, its business model and factor that are likely to affect its future performance. Also, the investor should have a long-term (2 to 3 years) investment horizon for only then would he realise adequate returns to his investments.

    Note: Characters in italics are quotes from Benjamin Graham.



    Equitymaster requests your view! Post a comment on "Markets: Rules for defensive investors". Click here!


    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    Jun 10, 2017

    Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

    Mr Trump Has Been Broken (Vivek Kaul's Diary)

    Aug 24, 2017

    Kelly, Mattis, McMaster, Cohn, and Mnuchin are in charge. But these Pentagon bureaucrats and Wall Street hustlers may be worse than a loose-cannon president.

    Were You Lured By Mr Market's Bait? (The 5 Minute Wrapup)

    Aug 23, 2017

    Mr Market lured investors into believing they'd bitten into a crash. Did you take the bait?

    Deep State First (Vivek Kaul's Diary)

    Aug 23, 2017

    Nowhere was the darkness deeper than in the nation's capital. There, no light shone. No flicker of awareness...observation...learning...or reflection appeared.

    Why Hasn't Warren Buffett Rung the Bell Yet? (The 5 Minute Wrapup)

    Aug 22, 2017

    It's surprising Warren Buffett hasn't warned investors about the expensive stock market? Let us know why.

    More Views on News

    Most Popular

    This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process)(The 5 Minute Wrapup)

    Aug 17, 2017

    A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.

    Dear PM Modi, India is Already Land of Self-Employed, and It Ain't Working(Vivek Kaul's Diary)

    Aug 21, 2017

    Most Indians who cannot find jobs, look at becoming self-employed.

    It's the Best Time to Buy IT Stocks(Daily Profit Hunter)

    Aug 16, 2017

    The IT Sector could be in an uptrend till February 2019. Are you prepared to ride the trend?

    5 Steps To Become Financially Independent(Outside View)

    Aug 16, 2017

    Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

    Think Twice Before You Keep Money In A Savings Bank Account(Outside View)

    Aug 22, 2017

    Post demonetisation, a cut in bank savings deposits rates was in the offing.

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms


    Aug 24, 2017 11:20 AM