AAII Stock Screens
Graham’s Long-Term
Winning Approach for
Enterprising & Defensive Investors
Value investing has proven
itself over time to be a highly
successful investment ap-
proach. And while success
has many fathers, Benjamin
Graham is certainly one of
them. In this case, father really
does know best.
Graham’s approach focuses on determining the “in-
trinsic” value of a stock, which takes into consideration the
firm’s earnings, tangible assets, dividends, financial strength
and stability. He believes investors should buy stocks whose
prices are close to their intrinsic value, and preferably those
that are priced lower than their intrinsic value.
AAII developed several screens based on Graham’s in-
vesting philosophy. Two of the screens, Graham Defensive
Investor (Non-Utility) and Graham Enterprising Investor,
were the top-performing value strategies in 2005, and both
have respectable long-term records.
This article briefly outlines Graham’s investing philoso-
phy, and then describes the performance and characteristics
of the two top-performing AAII screens that are based on
Graham’s value approach.
Graham’s Philosophy
In 1947, Graham published “The Intelligent Investor,”
a book that outlined in detail his investment philosophy, and
which he continued to update periodically. The book is now
considered an investment classic.
In the book, Graham describes how his approach would
be applied by two different types of investors—those that are
By Cara Scatizzi
“defensive” and those that are “enterpris-
ing.” The defensive, or passive, investor is
one who does not have or is not willing
to spend a great deal of time analyzing or
tracking individual stocks. In contrast, the
Enterprising Investor has greater market
experience, as well as additional time to
devote to portfolio management.
The Defensive Investor
For the Defensive Investor, Graham recommends pur-
chasing shares of “important” companies that have histories
of long-term profitability and strong financial positions. To
Graham, important companies are those of substantial size,
based on annual sales, with a leading position in a leading
industry. Additionally, Graham seeks companies with:
• Strong financial positions, as indicated by the current
ratio (current assets divided by current liabilities) and
the ratio of long-term debt to working capital (current
assets minus current liabilities);
• 10 years of positive earnings;
• 20 years of uninterrupted dividends;
• A 10-year annual earnings growth rate of at least 3%;
• A reasonable price-earnings ratio (Graham modifies this
ratio by averaging earnings over several years to overcome
business cycles and the impact of special charges);
• A moderately low ratio of price to assets (calculated by
multiplying the price-earnings ratio by the price-to-book
value ratio).
Enterprising Investors
Graham encourages Enterprising Investors to search for
April 2006 21
 AAII Stock Screens

Figure 1. Graham Screens • Current earnings higher than

earnings five years ago;
• A low price-to-book ratio.
450% Graham also suggests a mini-
S&P 500
Enterprising 400% mum of 10 holdings, but prefers a
larger group of 30 securities.
Defensive (Non-Utility) 350%
300% AAII’s Graham Screens
250% AAII developed two separate
200% screens that attempt to closely repli-
cate Graham’s principles, one for the
150% Defensive Investor and one for the
100% Enterprising Investor. The screens
were developed using Stock Inves-
50% tor Pro, AAII’s fundamental stock
0%
screening and research database.
These two screens were the
-50% top-performing value screens for
1998 1999 2000 2001 2002 2003 2004 2005 2006 2005.
A complete list of the screening
Monthly criteria for the two strategies can
Return (%)
1998 1999 2000 2001 2002 2003 2004 2005 YTD Cum'l
Std Dev
(%) be found at the end of this article.
Graham Defensive Investor (Non-Utility)*
Graham Enterprising Investor*
9.6 3.6 12.0 61.5 3.1 32.7 11.7 26.2 12.4
(7.3) (5.0) 24.2 55.3 43.5 25.9 18.9 21.3 16.5
345.0
415.8
5.9
8.0
Stock Investor Pro includes Graham’s
S&P 500 26.7 19.5 (10.1) (13.0) (23.4) 26.4 9.0 3.0 2.5 72.8 4.6 Defensive (Non-Utility)* and Enter-
S&P MidCap 400 17.7 13.3 16.2 (1.6) (15.4) 34.0 15.2 11.3 5.8 134.3 5.5
S&P SmallCap 600 (2.1) 11.5 11.0 5.7 (15.3) 37.8 21.4 6.7 8.3 109.7 5.8 prising Investor screens (along with
All Exchange-Listed Stocks 5.9 35.1 (14.2) 21.2 (13.3) 81.1 22.8 4.5
*Price performance of hypothetical portfolio rescreened and rebalanced monthly using month-end
7.9 223.7 6.6 a Defensive Investor (Utility) screen
closing prices and no transaction costs. not discussed in this article).
Data as of January 31, 2006.

promising investments among firms Table 1. Portfolio Characteristics for Graham Screens
outside of the “important” compa-
nies. He suggests looking among: Graham All
large companies unpopular, indicated Defensive Graham Exchange-
Investor Enterprising Listed
by a low price-earnings ratio (P/E); Portfolio Characteristics (Median) (Non-Utility) Investor Stocks
smaller companies in a top industry; Price-earnings ratio (X) 9.1 3.6 20.4
or, top firms in an unimportant in- Price-to-book-value ratio (X) 1.43 0.95 2.29
dustry. However, he advises against PE to EPS estimated growth (X) 0.95 0.40 1.40
small, undervalued companies, be- EPS 5-yr. historical growth rate (%) 22.7 20.8 10.2
lieving the company may not be able EPS 3-5 yr. estimated growth rate (%) 11.6 11.2 14.5
to sustain itself through an unstable Dividend yield (%) 1.4 1.8 0.0
or adverse market. Current ratio (X) 2.5 2.1 2.1
Additional criteria for Enterpris- LT debt to working capital (%) 38.9 26.5 17.5
ing Investors are: Market cap. ($ million) 2,708.5 17,621.7 457.6
• A price-earnings ratio in the bot- Relative strength vs. S&P (%) –18 12 0
tom 10% of all stocks;
• Financial strength based on the Monthly Observations
current ratio and ratio of long- Average no. of passing stocks 17 5
term debt to working capital; Highest no. of passing stocks 35 15
• Positive earnings for the past five Lowest no. of passing stocks 1 0
years; Monthly turnover (%) 21.2 35.4
• Dividend paying;

*Within AAII’s Stock Investor Pro, the Defensive Non-Utility Graham screen is labeled Graham (Defensive-Industrial), the Enterprising screen is
labeled Graham (Enterprising), and the Defensive Utility screen is labeled Graham (Defensive-Utility).

22 AAII Journal
 Performance
Figure 1 shows the performance
of the Graham Defensive (Non-Utility)
screen and the Graham Enterprising
Investor screen since 1998.
Both screens got off to a slow start,
lagging the S&P 500 until 2000 with the
Enterprising screen posting negative
returns for 1998 and 1999. However, the
Graham approaches are value-oriented,
so the early market-lagging performance
is not a surprise. The late 1990s marked
the tail-end of a bull market, an environ-
ment in which the focus was on growth
(particularly Internet stocks during this
tech bubble), and value approaches in
general tended to lag the market.
The market environment changed
dramatically when the technology sector
bubble burst, causing value to come into
favor once again. In 2001, both screens
saw their highest yearly return—61.5%
for the Defensive screen and 55.3% for
the Enterprising screen—in contrast to
the S&P 500, which lost 13.0%.
Cumulatively, each screen has
outperformed the S&P’s small-, mid-,
and large-cap indexes since 1998. The
Defensive Investor screen has gained
345.0% from January 1998 through
January 31, 2006, while the Enterprising
Investor screen logged a higher return
of 415.8% over the same period.
Determining the P/E Cut-Off for
Graham’s Defensive Investor
In “The Intelligent Investor,” Graham’s goal for the Defensive Investor
was to establish a portfolio whose earnings yield [earnings divided by price
(E/P), or the inverse of the price-earnings ratio] was at least comparable
to that of 10-year AA bonds. Therefore, he required the price-earnings
ratio to be no higher than the inverse of investment-grade bond yields.
Additionally, Graham modifies the price-earnings ratio by using the aver-
age earnings over the last three years to account for special charges and to
overcome cyclical business impacts.
At the time Graham wrote his book, investment-grade bonds were
yielding 7.5%; the inverse of that yield (1 divided by 0.075) determined the
overall portfolio price-earnings ratio objective of 13.3.
But current long-term high-grade corporate bond yields differ from those
prevailing when Graham set his price-earnings objective, and therefore the
cut-off needs to be adjusted. When bond yields increase, Graham’s formula
requires a lower price-earnings ratio. Conversely, lower bond yields mean
that an investor could accept a higher price-earnings cut-off, which makes
more stocks available for consideration.
The current AA 10-year bond yield is 5.1%; the inverse of the current
bond yield (1 divided by 0.051) is 20.
Profile of Passing Companies passed the Defensive Investor (Non-
Utility) screen, while only one passed
Table 1 lists the characteristics of the Enterprising Investor screen.
the stocks passing the Graham De-
fensive Investor (Non-Utility) screen Portfolio Turnover
and the Graham Enterprising Investor On average, the Defensive (Non-
screen as of February 10, 2006. Utility) screen has 17 stocks passing
Table 2 lists the passing stocks, each month, with an average monthly
ranked in ascending order by price-earn- turnover rate of 21.2%. The Enterpris-
ings ratio. The number of passing stocks ing screen has, on average, only five
for each screen is small—six companies stocks passing each month, with a 35.4%

Table 2. Companies Passing the Graham Screens

PE LT Debt/ 52-
Using EPS Current Working Wk
Company (Exch: Ticker) PE Avg EPS PB Grth Div Ratio Capital Mkt Rel
Graham Defensive Ratio 3 Yrs Ratio 7 Yr Yield Q1 Q1 Cap Strgth
Investor (Non-Utility) (X) (X) (X) (%) (%) (X) (%) ($Mil) (%) Description
Ashland Inc. (N: ASH) 2.4 5.7 1.3 39.5 1.7 2.7 3.6 4,598.0 –3.0 paving & spec chems
POSCO (ADR) (N: PKX) 3.6 8.0 1.0 30.5 1.8 2.1 26.5 17,621.7 12.0 mfgs steel
Schnitzer Steel (M: SCHN) 6.6 9.5 1.5 51.0 0.2 2.6 37.1 945.4 –18.0 auto parts & steel
Liz Claiborne, Inc. (N: LIZ) 11.5 13.6 1.8 11.8 0.7 2.3 46.9 3,643.1 –24.0 brand apparel
Briggs & Stratton (N: BGG) 12.9 15.2 2.0 9.2 2.6 2.4 59.1 1,773.8 –19.0 gas engines
Steel Tech (M: STTX) 14.0 11.9 1.3 19.3 1.1 3.4 40.6 345.3 –18.0 steel processor

Graham Enterprising Investor

POSCO (ADR) (N: PKX) 3.6 8.0 1.0 30.5 1.8 2.1 26.5 17,621.7 12.0 mfgs steel

Exchange Key: M= NASDAQ National or NASDAQ Small Cap Market, N= New York Stock Exchange.
Source AAII’s Stock Investor Pro
Pro/Reuters Research, Inc. Data as of 2/10/2006.

April 2006 23
 AAII Stock Screens
average monthly turnover rate.
It is not a surprise that both Gra-
ham screens have low turnover rates
compared to all of the strategies AAII
follows, since value strategies in general
tend to have lower turnover.
Price-Earnings Ratios
Because Graham focuses on finding
stocks selling at a significant discount,
the price-earnings ratio is an important
characteristic for both Defensive and
Enterprising Investors.
Graham’s Defensive Investor
screen uses a modified version of the
price-earnings ratio, which averages
earnings over several years to account
for special charges and to overcome the
impact of cyclical business. Graham’s
price-earnings ratio requirement for the
Defensive Investor seeks to produce a
stock portfolio that is reasonably priced
compared to the current yield of AA
bonds; in today’s interest rate environ-
ment, the Defensive Investor screen
requires a modified price-earnings ratio
of 20 or less [for more on how Graham
determines the price-earnings ratio for
the Defensive Investor, see the box on
page 23].
Graham set a more restrictive price-
earnings ratio level for Enterprising
Investors, who should look for stocks
with a price-earnings ratio in the lowest
10% of all stocks. As of February 10,
2006, that means a price-earnings ratio
of 9.5 or lower.
Due to the value orientation of
Graham’s screens, it is not surprising to
see in Table 1 that the median price-earn-
ings ratio of the passing companies (9.1
for Defensive and 3.6 for Enterprising)
is much lower than the typical exchange-
traded stock (20.4).
Table 2 shows that Steel Tech-
nologies, Inc. is the “richest” passing
company, with a price-earnings ratio
of 14.0.
Price-to-Book Ratios
Graham also looks for securities
with low price-to-book ratios, generally
below 1.5. However, he feels that a low
price-earnings ratio can justify a slightly
higher price-to-book ratio.
24 AAII Journal
Graham recommends that Defen-
sive Investors multiply the price-earn-
ings ratio by the price-to-book ratio
and seek stocks where that value does
not exceed 30 (an acceptable modified
price-earnings ratio of 20 times a 1.5
price-to-book ratio).
Graham recommends that Enter-
prising Investors should look for stocks
with a price per share that is less than
or equal to 1.2 times its tangible book
assets (price-to-book ratio), a more
restrictive criteria.
Not surprisingly, given these restric-
tions, Table 1 indicates that the median
price-to-book ratios for both the De-
fensive screen (1.43) and Enterprising
screen (0.95) are less than the typical
exchange-traded stock (2.29).
Earnings Stability
Earnings stability is another impor-
tant principle for Graham. Both screens
require positive historical earnings and
strong earnings growth rates.
The Graham Defensive (Non-Util-
ity) screen requires seven years of posi-
tive earnings and a seven-year annualized
earnings per share growth rate of 3%
or higher. [Although Graham suggests
investors examine a 10-year earnings
history, the AAII screen is constrained
by the Stock Investor Pro database earn-
ings history, which is limited to seven
years.]
The Graham Enterprising screen is
less restrictive, requiring only positive
earnings over the last five years; it also
requires that current fiscal-year earnings
be higher than earnings five years ago.
Both screens have a higher historical
earnings growth rate—22.7% for Defen-
sive and 20.8% for Enterprising—than
the average exchange-traded stock, with
a 10.2% median growth rate.
Among the passing companies listed
in Table 2, Briggs & Stratton Corpora-
tion has the lowest seven-year annualized
earnings growth rate of 9.2%, while
Schnitzer Steel Industries has an impres-
sive 51.0% annualized growth rate.
Graham’s focus on strong earnings
growth and low price-earnings ratios
is reflected in the lower median PEG
ratios (price-earnings ratio divided by
the estimated earnings per share growth
rate for five years).
Dividends
In addition to earnings growth,
Graham is a firm believer in dividends.
Both screens look for companies that
pay dividends.
The Graham Defensive (Non-
Utility) screen requires that a company
has paid a dividend over the trailing 12
months and for each of the last seven
years. [Although Graham suggests inves-
tors examine a 20-year dividend history,
the AAII screen is constrained by the
Stock Investor Pro database dividend his-
tory, which is limited to seven years.]
As with other criteria for the Enter-
prising Investor, the dividend criteria for
this screen is more relaxed, only calling
for a dividend payment over the trailing
12-month period.
Both screens also require that a
company intends to pay a dividend over
the next four fiscal quarters.
Dividend yields for the current list
of passing companies range between
0.2%, for Schnitzer Steel, and 2.6%, for
Briggs & Stratton Corporation.
Strong Financial Position
Graham believes that a company
with a strong financial position can
continue to prosper—or at least not
fail—during a downturn in the market.
A firm’s current ratio (current assets
divided by current liabilities) shows
the liquidity of a company’s assets; the
higher the ratio, the stronger the financial
position of the firm.
The Graham Defensive Investor
screen looks for stocks with a current ra-
tio of at least 2.0, while the Enterprising
Investors screen considers stocks with a
slightly lower current ratio of 1.5.
Table 2 shows that Steel Technolo-
gies Inc. currently has the highest current
ratio of 3.4.
In addition to liquidity, Graham
looks to long-term debt and its relation-
ship to working capital (current assets
minus current liabilities) as another
measure of financial stability.
For both screens, Graham believes
long-term debt should not exceed net
current assets or working capital. The
AAII screens have quantified this by
using a long-term debt to working
capital ratio, which, Graham specifies,
should always be positive and less than
or equal to 100%.
Table 2 indicates that Ashland Inc.
has by far the lowest ratio of long-term
debt to working capital, at 3.6%.
Market Capitalization
Most of the stocks currently passing
these two screens have median market
capitalizations much larger than the
typical exchange-listed stock ($457.6
million). This is to be expected, since
Graham favors larger companies, and
the Defensive Investor (Non-Utility)
screen requires annual sales of at least
$400 million. (The annual sales require-
ment has been raised from Graham’s
original recommendation of $100 mil-
lion due to inflation.)
The median market cap of a
stock currently passing the Defensive
Investor (Non-Utility) screen is $2.7
billion while the one stock passing
the Enterprising screen has a market
capitalization of $17.6 billion. Three of
the six companies passing the Defensive
screen, including the one company also
passing the Enterprising screen, are in
the steel business. Most likely this is
due to the cyclical nature of the steel
industry and a slowing demand for cars
and new homes.
Relative Strength
Over the past 52 weeks, the stocks
currently passing the Defensive Investor
(Non-Utility) screen have underper-
formed the S&P 500 by 18%, while the
single stock passing the Enterprising
Investor screen has outperformed the
market by 12%.
The typical exchange-traded stock
has matched the performance of the
S&P over the same time period (relative
strength of 0%).
Conclusion
Graham’s investing philosophy
focuses on finding larger, well-known
companies with strong historical growth
rates that are selling at a discount. De-
spite a slow start in 1998 and 1999, this
approach, as embodied in AAII’s Gra-
ham Defensive Investor (Non-Utility)
and Enterprising Investor screens, has
proved to be a winning strategy over
the last eight years.
The passing companies of each
screen do not represent a list of rec-
ommended stocks. As with all types of
investing, it is important to perform due
diligence to verify the stock’s financial
strength and earning potential. It is also
essential to decide if the stocks match
your investing style and risk tolerance
before committing your investment
dollars. 

What It Takes: Graham Criteria

Defensive (Non-Utility):
• Those companies that are part of the utilities sec-
tor are excluded
• Sales over the last 12 months are greater than or
equal to $400 million
• The current ratio for the last fiscal quarter (Q1)
is greater than or equal to 2.0
• The long-term debt to working capital ratio for
the last fiscal quarter (Q1) is greater than 0% and
less than 100%
• Earnings per share for each of the last seven fiscal
years and for the last 12 months are positive
• The seven-year growth rate in earnings per share
is greater than 3%
• The company intends to pay a dividend over the
next year (indicated dividend greater than zero)
• The company has paid a dividend for each of
the last seven fiscal years and over the last 12
months
• A modified price-earnings ratio of 20 or less (see
box on page 23)
• The price-earnings ratio multiplied by the price-to-
book ratio is less than or equal to 30 (price-earn-
ings ratio maximum of 20 times 1.5, which is the
maximum price-to-book ratio)
Enterprising:
• The price-earnings ratio is among the lowest 10%
of the database (Percent Rank less than or equal
to 10)
• The current ratio for the last fiscal quarter (Q1) is
greater than or equal to 1.5
• The long-term debt to working capital ratio for
the last fiscal quarter (Q1) is greater than 0% and
less than 110%
• Earnings per share for each of the last five fiscal
years and for the last 12 months have been posi-
tive
• The company intends to pay a dividend over
the next year (indicated dividend is greater than
zero)
• The company has paid a dividend over the last 12
months
• Earnings per share for the last 12 months are
greater than the earnings per share from five years
ago (Y5)
• Earnings per share for the last fiscal year (Y1) are
greater than the earnings per share from five years
ago (Y5)
• The price-to-book ratio is less than or equal to
1.2

Cara Scatizzi is associate financial analyst at AAII.

April 2006 25