The Benjamin Graham number that I have mentioned In a few articles and use in my Dividend Stock Analysis is not a very popular formula. It has even been said that it doesn't paint a good picture of a value stock.. In fact, at any given time, there are not many stocks on the TSX that will actually be under the Graham number. Of course, with the current market situation, just about every stock should be close if not below the Graham number, due to the dramatic fall of stock prices. For anyone who does not know, Benjamin Graham is considered the Grandfather of Value investing. His methods and ideas have been used as a cornerstone or building block of just about every value based investor since he published his book, "The Intelligent Investor". Another thing to note, is that Benjamin Graham is said to have been the mentor of investing great, Warren Buffett.
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So what exactly is the Graham Number? Simply put, the graham number is the maximum price that a defensive investor should pay for a security. I believe this number was originally intended to be an exit price from a stock, so you would buy a stock if it was under this price, and then once it hit this price, or went above, a defensive investor would be advised to sell the stock. The problem with this, is you would often sell a stock when it still had a lot of upside still available. I like to use this number as a price point, so if the current price is under this, I like to think of the stock as a good value pick.
Calculating the Graham Number is very simple. You will need two numbers to make the calculation, the Earnings Per Share (EPS) and the Book Value per Share (BVPS).
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To calculate the Earnings Per Share (EPS), you take the Net Earnings and divide that by the Outstanding Shares.
To get the Book Value Per Share, you take the Book Value(which is Assets minus Liabilities) and you divide that by the Outstanding Shares.
Once you have those two values, you can calculate the Graham Number by taking the Square Root of 22.5 multiplied by the Earnings Per Share multiplied by the Book Value Per Share.
so as a formula it would look like the following, SQRT(22.5 * EPS * BVPS)
or if you want to view the fully expanded version, SQRT(22.5 * (Net Earnings/Outstanding Shares) * ((Assets - Liabilities)/Outstanding Shares))
It would only be fair, if I gave you an example of the Graham Number in action. So lets take a look at one of my favorite dividend based stocks, Saputo Inc. (TSE: SAP)
According to their 2008 Annual statement, Saputo has net earnings of $288.20 Million, Total Equity (assets - liabilities) of $1619.16 Million, and a total of 206.81 Million shares outstanding.
This means that they have an EPS of 288.20/206.81 = 1.39, and a BVPS of 1619.16/206.81 = 7.83. So Saputo's Graham number would be SQRT(22.5 * 1.39 * 7.83) = $15.65
So, at this point in time, Saputo Inc. (TSE: SAP) would be a value pick if its price were to fall below $15.65 and since its current price is 23.05 (at the time of this writting) that would mean that right now, SAP would not be a good value pick.
I hope that this breif introduction to the Graham Number and the example have helped show you a new tool that you could use when choosing your value based stocks.
Disclaimer: Any information contained in the above article represents my opinions only, and should not be construed as personalized investment advice. I cannot assess, verify or guarantee the suitability of any particular investment to any particular situation and the reader of the article bears complete responsibility for its own investment research and should seek the advice of a qualified investment professional that provides individualized advice prior to making any investment decisions. All opinions expressed and information and data provided therein are subject to change without notice.