Graham’s Stock Selection Screen Part 2

Written by

Jae Jun

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Previously I went through 4 combinations from the list of Benjamin Graham’s 10 criteria for stock selection.

Due to the many responses and requests for other combinations, I’ll be going through different conditions. I’ll also try to find the best performing condition to add to the value screens section.

Do take time to read the comments of the first article as it provides excellent additional information about the article as well as the screen itself.

And If you missed the original article, follow the links to get up to date.

Here are a couple of comments that I feel should be read.

Reader “Eldinril“, mentioned

..this is referred to as Graham’s Last Will and Testament. It was written by a man named James Rae, who became friends with Graham in the last few years of his life…

I recall reading once that Rae and/or his son attempted to run money using the ten-point checklist, but achieved lackluster results. I find it particularly intriguing to compare this checklist to the list of criteria included in the later editions of “The Intelligent Investor”. It is important to understand that this particular checklist was the result of conversations between Graham and Rae. Some of the details were the result of compromises between the two of them.

Reader “R” also brought up an interesting point.

..after coming up with these 10 points, Graham said that you could achieve the same result by selecting stocks with only the following 3 out of 10 points: Dividend yield at least 2/3rd AAA bond, Earning yield at least twice the AAA yield, debt to equity less than 1. Which means 1 3 and 6 above. Other points are redundant. See how the performance of a portfolio of those companies look like. I think there was an article on a recent AAII publication.

List of 10 Stock Selection Criteria by Benjamin Graham

1. An earnings-to-price yield at least twice the AAA bond rate

2. P/E ratio less than 40% of the highest P/E ratio the stock had over the past 5 years

3. Dividend yield of at least 2/3 the AAA bond yield

4. Stock price below 2/3 of tangible book value per share

5. Stock price below 2/3 of Net Current Asset Value (NCAV)

6. Total debt less than book value

7. Current ratio great than 2

8. Total debt less than 2 times Net Current Asset Value (NCAV)

9. Earnings growth of prior 10 years at least at a 7% annual compound rate

10. Stability of growth of earnings in that no more than 2 declines of 5% or more in year end earnings in the prior 10 years are permissible.

Test Combination of Criteria

The following combination of screen conditions have been applied

  • (1),(2),(3)
  • (1),(2),(3),(6)
  • (1),(2),(3),(6),(7)
  • (1),(2),(3),(6),(7),(8)
  • (1),(2),(3),(6),(7),(8),(9)

The test conditions remain the same as the original and although I’ve received historical bond yield information, I have no idea how to incorporate it into my screen so I’ll have to stick with a static 4.5%.

I intentionally left out conditions (4) and (5) because these two produce zero results. It is best left as a standalone NCAV screen that I have available already.

As I was performing the screen, I noticed that the results of  (1),(2),(3),(6),(7),(8) was poorer compared to just (1),(2),(3),(6),(7), which means that condition (8) is a hindrance on performance.

I also noticed the same thing with condition (3):Dividend yield of at least 2/3 the AAA bond yield. The screen performed better without the dividend yield requirement.

This is a surprise because everyone has been saying that (3) is a main condition.

Or is it because of the drop after each dividend payment?

Old School Value’s Version of Graham’s Guru Screen

But before I get into the criteria, click on the image below to get the best investment checklist that will help organize your thoughts and make things easier for you.

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Here is what I have found to be the best stock selection criteria.

1. An earnings-to-price yield at least twice the AAA bond rate

2. P/E ratio less than 40% of the highest P/E ratio the stock had over the past 5 years

6. Total debt less than book value

7. Current ratio great than 2

Surprisingly very simple.

Stocks from the Best Performing Graham Checklist

I’ve added the above stocks to a virtual portfolio for you to track over time. Click to see the Graham Checklist Screen.

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