Value OF A STOCK Calculator

This calculation has been done using Graham Number

When it comes to stock investing, finding a reliable method for determining the intrinsic value of a company is crucial. One such method is the Graham Number, a formula popularized by Benjamin Graham, widely regarded as the father of value investing. Graham was the mentor of Warren Buffett, and his conservative investment philosophy has influenced countless investors.

What is the Graham Number?

The Graham Number is a figure that represents the fair value of a stock based on two key financial metrics: earnings per share (EPS) and book value per share (BVPS). This number is particularly useful for value investors who seek to buy stocks that are undervalued compared to their intrinsic worth.

The Graham Number Formula

The Graham Number is calculated using the following formula: √ 22.5 x EPS x BVPS 

  • Earnings Per Share (EPS): This is the portion of a company's profit allocated to each outstanding share of common stock. It serves as an indicator of a company's profitability.
  • Book Value Per Share (BVPS): This represents the company's total assets minus its total liabilities, divided by the number of outstanding shares. It is essentially the net asset value of the company per share.

The constant 22.5 is derived from Graham's conservative assumption that a stock should not have a price-to-earnings (P/E) ratio higher than 15 or a price-to-book (P/B) ratio higher than 1.5. The product of these two multiples (15 * 1.5) gives us 22.5.

Importance of the Graham Number

  1. Conservative Valuation: The Graham Number is designed to provide a conservative estimate of a stock's value, which is particularly useful for risk-averse investors. It helps avoid overpaying for a stock.
  2. Simplified Screening Tool: Investors can use the Graham Number as a quick way to screen for potentially undervalued stocks. If a stock’s current price is significantly lower than its Graham Number, it might warrant further investigation.
  3. Long-Term Focus: The formula is best suited for long-term investors who focus on a company’s fundamental strength rather than short-term market fluctuations.

Limitations of the Graham Number

While the Graham Number is a powerful tool, it has its limitations:

  1. Ignores Growth Prospects: The formula does not account for a company’s growth potential. High-growth companies might appear overvalued by this metric even if they have strong future prospects.
  2. Suitable for Established Companies: The Graham Number is most effective for established companies with consistent earnings and book values. It may not be suitable for start-ups or companies with volatile earnings.
  3. Static Analysis: The Graham Number is based on historical financial data, making it a snapshot in time. It does not adjust for changes in the company’s business environment or future performance.

Practical Use of the Graham Number

Investors should not rely solely on the Graham Number when making investment decisions. It is best used in conjunction with other financial ratios and qualitative analysis. Factors such as the company’s competitive position, management quality, and industry conditions should also be considered.