1 Hidden Investment Idea Within “The Intelligent Investor,” A Book That Changed Warren Buffett’s Life

One of the most important books for value investors would be The Intelligent Investor, written by the late Benjamin Graham. Billionaire investor Warren Buffett has even publicly stated that the book had changed his life.

Two key investment concepts described in the book are (1) the margin of safety, and (2) Mr. Market. However, the book is more than just the two concepts. In fact, there’s an often overlooked but important idea within The Intelligent Investor.

Criteria for stocks

Graham was a well-known value investor. He looked for stocks that are typically trading at very cheap valuations and that have very favourable risk-to-reward ratios. In The Intelligent Investor, he offered a glimpse into the criteria he used when he was studying a stock. These are the five criteria he wrote about:

1) Financial Condition – The company should have current assets of at least 1.5 times its current liabilities; and its debt should not be more than 110% of its net current assets.

2) Earnings Stability – The company should be profitable over the last five years.

3) Dividend Record – The company should be paying a dividend.

4) Earnings Growth – The company’s earnings should have a long-term track record of growth.

5) Valuation – The company’s price-to-book (PB) ratio should be below 1.2.

When to use the criteria

Graham included the criteria in the “Stock Selection for the Enterprising Investor” chapter within The Intelligent Investor. This means that the criteria is meant for relatively aggressive investors, as opposed to defensive investors.

But, it is worth noting that Graham’s criteria is not necessarily the “right” way to invest. What it is, is a reminder that investing is all about the process, instead of simply stepping into the market and speculating on stocks.

As investors, we have to know that the first step in a successful investing journey is to have a clear process. The second step is to follow the process. Without a clear process and the determination to follow it when buying or selling stocks, we are merely speculating.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.