Benjamin Grahams' 7 ways to select high value stocks

Key takeaways:

• Graham's seven criteria screen for company size, financial strength, earnings stability, dividend history, earnings growth, and reasonable valuation (P/E and P/B ratios)
• The Graham Number formula — √(22.5 × EPS × Book Value) — combines his P/E and P/B limits into a single fair-value estimate
• Very few stocks pass all seven criteria simultaneously in today's market; modern investors adapt the thresholds by sector
• The "margin of safety" — buying at a significant discount to intrinsic value — remains the single most important concept in Graham's framework
• Indian investors can screen US stocks using these criteria through free tools like Finviz and fundamental analysis frameworks

Warren Buffett once said that reading The Intelligent Investor at age 19 was the most important investing decision he ever made. The book's author, Benjamin Graham, didn't just teach Buffett how to pick stocks. He created an entire framework for thinking about what a stock is actually worth — and, more importantly, what you should pay for it.

That framework boils down to seven specific, measurable criteria. No guesswork. No gut feeling. Just numbers that tell you whether a company is financially sound and trading below what it's worth.

Here's why this matters if you're investing from India: these criteria work regardless of where you sit. Whether you're screening stocks on the NYSE or looking at S&P 500 components through a platform like Winvesta, the maths doesn't change. A company's current ratio is the same in Mumbai as in Manhattan.

Let's break down each criterion, what it actually means, and how you can use it today.

Who was Benjamin Graham?

Graham was a Columbia University professor, fund manager, and the person who essentially invented the discipline of security analysis. He published Security Analysis in 1934 and The Intelligent Investor in 1949 — both during periods of extreme market volatility that would have wiped out investors without a systematic approach.

His most famous student was Warren Buffett. But Graham's influence extends far beyond one investor. His ideas on intrinsic value, margin of safety, and the distinction between investing and speculation underpin how professional money managers evaluate stocks worldwide.

Graham divided investors into two categories: defensive (passive) investors who want safety and minimal effort, and enterprising (active) investors willing to put in more research time. The seven criteria below are specifically designed for the defensive investor — the person who wants a reliable system without spending 40 hours a week on stock analysis.

Graham's 7 criteria for the defensive investor

1. Adequate size of the enterprise

Graham's benchmark: Minimum $100 million in annual sales (originally from 1973; inflation-adjusted, this translates to roughly $500 million+ today, though different sources quote slightly different adjusted figures — the key point is "large, prominent companies").

Graham wanted to exclude small companies because they tend to experience wider earnings swings and are more vulnerable to competitive threats. Large companies aren't immune to problems, but they generally have more resources to weather downturns.

In practice, this criterion steers you toward mid-cap and large-cap stocks. If you're screening US stocks, this eliminates most companies below the S&P MidCap 400.

2. Strong financial condition

Graham's benchmark: Current ratio of at least 2:1 (current assets should be at least twice current liabilities). Long-term debt should not exceed net current assets (working capital).

This is Graham's liquidity test. A current ratio of 2:1 means the company has enough current assets to cover its current liabilities twice over. The debt constraint ensures the company isn't over-leveraged.

The debt-to-equity ratio gives you a complementary view here. Graham was especially wary of companies that looked profitable on the income statement but were dangerously stretched on the balance sheet.

Note: Graham made exceptions for utilities (which typically carry higher debt) and noted that financial companies like banks report balance sheets differently, so the current ratio criterion doesn't apply directly to them.

3. Earnings stability

Graham's benchmark: Positive earnings in each of the past 10 years. No deficit years.

This isn't about earnings growth — it's about consistency. Graham wanted companies that didn't post losses even during recessions. A single loss year in a decade disqualifies a stock under this criterion.

This is a high bar. Many cyclical companies in the energy, mining, and airline sectors would fail this test. That's intentional. Graham designed these criteria for defensive investors who prioritise capital preservation over maximum returns.

4. Dividend record

Graham's benchmark: Uninterrupted dividend payments for at least the past 20 years.

Twenty years of consecutive dividends signal something important: the company generates enough cash to reward shareholders through multiple economic cycles. It also indicates that management has the discipline to maintain payouts even during tough periods.

This criterion eliminates most technology companies and high-growth stocks, which tend to reinvest profits rather than distribute them. That's a deliberate trade-off in Graham's framework — you sacrifice potential upside for income certainty.

For Indian investors evaluating US stocks, remember that earnings-per-share growth often precedes dividend initiation. Young companies grow; mature companies distribute.

5. Earnings growth

Graham's benchmark: Minimum increase of one-third in per-share earnings over the past 10 years, using three-year averages at the beginning and end.

Graham used three-year averages to smooth out unusual years. So you'd compare the average EPS from years 1–3 with the average from years 8–10. If that comparison shows at least a 33% increase, the company passes.

This works out to roughly 2.9% compound annual growth — not an ambitious target. Graham wasn't looking for high-growth rockets. He wanted steady, demonstrable progress that shows the business is moving forward, not just treading water.

6. Moderate price-to-earnings ratio

Graham's benchmark: Current price should not exceed 15 times average earnings of the past three years.

The P/E ratio is probably the most widely used valuation metric in investing. Graham's limit of 15x was roughly in line with the historical S&P 500 average when he was writing.

Here's where things get tricky in today's market. The S&P 500's trailing P/E has frequently exceeded 20x since 2010 and recently sits above 25x. Applying a strict 15x ceiling would eliminate most of the index.

This is why many modern value investors use Graham's P/E criterion as a relative filter rather than an absolute one — looking for stocks trading at a significant discount to their sector average rather than requiring a hard 15x cap.

7. Moderate price-to-assets ratio

Graham's benchmark: Current price should not exceed 1.5 times the last reported book value. However, Graham allowed a trade-off: a lower P/E could justify a higher P/B, provided the product of P/E × P/B does not exceed 22.5.

This is where Graham's criteria get elegant. The 22.5 ceiling means a stock at 15x earnings can have a P/B of only 1.5 (15 × 1.5 = 22.5). But a stock at 10x earnings could have a P/B of up to 2.25 (10 × 2.25 = 22.5).

The price-to-book ratio has become less useful for technology companies whose value is driven by intangible assets such as software, patents, and network effects. But for traditional sectors — banking, manufacturing, energy, consumer staples — it remains a powerful screen.

All 7 criteria at a glance

The Graham Number: all seven criteria in one formula

Graham's quantitative criteria (#6 and #7) combine into a single formula known as the Graham Number:

Graham Number = √(22.5 × EPS × Book Value Per Share)

This calculates the maximum price a defensive investor should pay. Here's a quick example:

• Company's EPS (3-year average): $6
• Book value per share: $50
• Graham Number: √(22.5 × 6 × 50) = √6,750 = $82.16

If the stock trades below $82.16, it passes Graham's combined valuation test. If it trades above that level, it's too expensive by his standards.

The Graham Number is available as a pre-calculated metric on screening tools like GuruFocus and the GrahamValue screener — useful for quickly filtering large stock universes before doing deeper fundamental analysis.

The margin of safety: Graham's most important idea

Every criterion above serves one purpose: finding stocks where you're paying less than what the business is actually worth. Graham called this gap the margin of safety, and he considered it the most important concept in investing.

Think of it this way. If you estimate a stock's intrinsic value at $100 and buy it at $65, your margin of safety is 35%. That buffer protects you if your analysis is slightly wrong, if the economy hits a rough patch, or if the company faces an unexpected setback.

Graham typically sought margins of at least 33% — buying at two-thirds or less of calculated intrinsic value. Buffett later described this as wanting to buy a dollar for 50 cents.

The margin of safety isn't a separate criterion. It's the outcome of applying all seven criteria together. When a stock passes Graham's screens, the margin is already built in.

Applying Graham's criteria in today's market

Here's the honest truth: if you apply all seven criteria strictly, very few stocks pass. In some years, not a single stock in the Dow Jones Industrial Average meets every threshold.

That doesn't mean the criteria are broken. It means the market environment has changed since the 1970s. Here's how modern value investors adapt Graham's framework:

Sector-specific adjustments

Technology stocks — Most trade at P/E ratios well above 15x and have minimal tangible book value. Applying Graham's raw numbers here would eliminate every major tech company. The PEG ratio can help bridge Graham's value framework with growth expectations.

Financial stocks — Banks and insurers don't report current assets and liabilities the same way industrial companies do. Graham acknowledged this and proposed alternative solvency measures for the financials.

Utility stocks — Graham relaxed the current ratio requirement for utilities, recognising that their regulated, predictable cash flows make higher debt levels more sustainable.

The enterprising investor criteria

Graham also published a less strict set of criteria for active investors willing to do more research. Modern backtests typically operationalise his enterprising criteria along these lines (this is a codified screen based on Graham's principles, not a word-for-word list from the book):

These relaxed thresholds typically surface more candidates. Backtesting by researchers at Old School Value found that using just four of Graham's selection criteria (earnings yield, relative P/E, dividend yield, and current ratio) produced solid returns over 18 years of testing.

Using screening tools

You don't need to calculate these ratios by hand. Free tools make it straightforward:

• Finviz — Screen by P/E, P/B, current ratio, and market cap
• GrahamValue.com — Applies Graham's defensive and enterprising criteria automatically to global stocks
• GuruFocus — Calculates the Graham Number for every listed company
• SEC EDGAR — Source of truth for US company financial statements (10-K and 10-Q filings)

For a systematic approach to building your own evaluation process, our fundamental analysis checklist walks through each step.

What Graham's criteria miss

Graham designed his system in an era when most publicly traded companies were industrial manufacturers with heavy tangible assets. The modern economy looks different. Here's what the criteria don't capture:

Competitive moats — A brand like Apple or a network like Visa creates enormous value that doesn't show up on the balance sheet. Buffett evolved beyond Graham's pure quantitative approach specifically because he recognised the importance of qualitative advantages.

Management quality — Graham deliberately excluded subjective judgments from his criteria. But decades of evidence show that management integrity and capital allocation skills matter enormously. The Super Micro accounting controversy in 2024 is a recent reminder that cheap metrics mean nothing if the financials can't be trusted.

Intangible assets — Software, patents, customer data, and subscription revenue don't appear in book value calculations. This is why the P/B ratio has become less useful for companies in knowledge-based industries.

Growth potential — Graham's 2.9% annual earnings growth floor is deliberately low. Companies growing at 15-20% annually may look "expensive" on Graham's criteria, but could still represent excellent long-term value.

The smartest approach combines Graham's quantitative rigour with qualitative analysis. Screen first using the numbers. Then dig deeper using fundamental vs. technical analysis frameworks.

Putting it all together: a practical approach for Indian investors

If you're investing in US stocks from India, Graham's criteria give you a tested starting point. Here's a practical workflow:

Step 1: Screen. Use Finviz or GuruFocus to filter for US stocks with a P/E under 15, a P/B under 1.5, a current ratio above 2, and 10+ years of positive earnings. You'll typically get 20–50 names.

Step 2: Calculate the Graham Number. For each stock that passes the initial screen, check whether the current price sits below the Graham Number. This eliminates borderline cases.

Step 3: Check the dividend record. Verify at least 10 years (if not Graham's full 20) of consecutive dividend payments. Resources like Seeking Alpha's dividend history page make this quick.

Step 4: Read the 10-K. For the top candidates, read the most recent annual report on SEC EDGAR. Look for management commentary on competitive position, capital allocation priorities, and risk factors.

Step 5: Apply the margin of safety. Only invest when the stock price sits at least 25–33% below your intrinsic value estimate. If the margin isn't there, move on.