What Is Graham Number? Meaning, Formula & Example

Value investing is based on one fundamental concept: buying good businesses at fair prices. The most commonly used technique to evaluate the undervaluation of stocks is Graham Number, which is a form of stock valuation developed by the famous investor Benjamin Graham, who is considered to be the father of value investing.
 

Instead of basing his evaluation only on stock prices, Benjamin Graham used the earnings per share (EPS) and book value per share (BVPS) in order to come up with an estimated maximum price for the stock to be bought.
 

In this article, you will learn what is Graham Number, how it is calculated, why investors need it, and what its drawbacks are in today's stock market.

Graham Number Meaning

Graham Number is a formula used in determining the fair value of an equity investment by value investors using the earnings and book value of the stock.

This formula does not seek to forecast the future prices but helps in comparing the market price of the stock with its fair value.

In Layman’s Terms:

• A stock that is trading below its Graham Number may be considered a potential bargain by certain investors.
• One that is trading above its Graham Number may be regarded as being expensive according to this approach.

Nevertheless, the Graham Number is meant to complement financial analysis, and not act alone as an investing indicator.

Origin of Graham Number (Benjamin Graham)

The Graham Number is derived from the concepts of investing espoused by Benjamin Graham, who provided the basis of modern-day value investing.

• According to Graham, the following aspects were important for investors when selecting stocks:
• High levels of profit
• Sound financial position
• Good valuation
• Margin of safety

Many successful investors like Warren Buffett have been inspired by Graham's teachings.

The Graham Number represents this conservative view through an integration of profitability and book value.

Graham Number Formula

The Graham Number is calculated using:

22.5× (Earnings Per Share) × (Book Value Per Share)

Where:

• EPS = Earnings Per Share
• BVPS = Book Value Per Share
• 22.5 = Graham's suggested maximum combination of a Price-to-Earnings ratio of 15 and a Price-to-Book ratio of 1.5.

The formula aims to provide a conservative estimate rather than an exact intrinsic value.

How to Calculate Graham Number

The Graham Number calculation consists of only three straightforward steps.

• Step 1: Finding EPS

Get the EPS value of the company from its financial statements.

• Step 2: Finding BVPS

Calculate the BVPS value.

• Step 3: Plugging into the Formula

Plug both values into the formula for the Graham Number.

Example:

• EPS = ₹20
• BVPS = ₹50

Calculation:

22.5×20×50=22500=150\sqrt{22.5\times20\times50}=\sqrt{22500}=15022.5×20×50​=22500​=150

The Graham Number is ₹150.

Example of Graham Number Calculation

Let's look at a practical example.

In this example:

• Current Price = ₹130
• Graham Number = ₹150

Some value investors might view this stock as trading below its Graham Number, although additional research would still be necessary before making an investment decision.

Importance of Graham Number in Investing

The Graham Number continues to be popular since it encourages investors to invest in a more disciplined manner.

Helps Identify Undervalued Stocks

It acts as an efficient screening tool for the value investor.

Encourages Fundamental Analysis

The formula uses the earnings and balance sheet strength of a company and not just price action.

Encourages Long-Term Investing

It promotes the principle of long-term investing as opposed to short-term speculation.

Encourages Investing within a Margin of Safety

Graham emphasized that investors should not overpay for good companies.

Advantages of Using Graham Number

Some of the advantages that the Graham number has include:

Simple Formula

It only requires two financial figures.

Objective Screening Method

It gives an objective approach to evaluating companies.

Fiscal Strength

It takes both profitability and book value into consideration.

Value Investing

It is especially suitable when using traditional value investing.

Limitations of Graham Number

In spite of the benefits that it brings to the table, Graham Number has notable drawbacks.

Growth Is Not Factored in

Rapidly growing companies will look pricey even when their earnings in the future support such an evaluation.

Worse Fit for Companies without Assets

Technology and service companies usually do not have high book values.

Based on Historic Numbers

The model uses historic earnings and book value of a company instead of future performance.

Not a Standalone Tool

Other factors such as cash flow, management, debt, and industry need to be considered.

Graham Number vs Intrinsic Value

Although both concepts estimate fair value, they differ in approach.

The Graham Number is best viewed as a starting point rather than a complete valuation method.

How Investors Use Graham Number

Most investors incorporate the Graham Number into their research process.

The common steps taken include:
 

• Stock screening by the Graham Number.
• Comparison of the value with the present market price.
• Analysis of the financial statements.
• Analyzing the debts and profitability.
• Industry analysis.
• Decision-making based on various valuation techniques.
   

This is to ensure that the investor does not depend on just one formula in valuing the company.
 

Before opening a trading account to invest in stocks, it's useful to understand the documents required for opening a trading account and the KYC process.
 

Conclusion

The Graham Number continues to be among the easiest valuation tools that can help find out the potential undervaluation of stocks. With the combination of Earnings Per Share and Book Value Per Share, it offers a conservative estimation of the fair value for purchase by a value investor.

At the same time, no valuation method can be considered separately. It is worth using the Graham Number in conjunction with overall fundamental analysis, research in the particular industry, and evaluation of business itself. You can also explore our Option trading tips to understand better about option trading.