Graham Number Definition Formula Example and Limitations

Graham Number: Definition, Formula, Example, and Limitations

The Graham Number is a financial metric used by investors to evaluate the fair value of a stock. It was developed by the legendary investor Benjamin Graham, who is considered the father of value investing. The Graham Number takes into account both the company’s earnings per share (EPS) and its book value per share (BVPS) to determine whether a stock is undervalued or overvalued.

The formula for calculating the Graham Number is as follows:

Graham Number = √(22.5 × EPS × BVPS)

To calculate the Graham Number, you need to know the company’s EPS and BVPS. EPS is the company’s net income divided by the number of outstanding shares, while BVPS is the company’s total equity divided by the number of outstanding shares.

Let’s take an example to illustrate how the Graham Number works. Suppose a company has an EPS of \$3 and a BVPS of \$20. By plugging these values into the formula, we can calculate the Graham Number as follows:

Graham Number = √(22.5 × 3 × 20) = √(1350) ≈ \$36.74

What is Graham Number?

The Graham Number is a financial metric used to evaluate the intrinsic value of a stock. It was developed by Benjamin Graham, a renowned investor and author of the book “The Intelligent Investor.” The Graham Number is calculated by taking the square root of the product of a company’s earnings per share (EPS) and book value per share (BVPS) and multiplying it by a factor of 22.5.

The formula for calculating the Graham Number is as follows:

Graham Number = √(EPS * BVPS) * 22.5

The Graham Number is used by value investors to identify stocks that are trading at a discount to their intrinsic value. By comparing a stock’s current market price to its Graham Number, investors can determine whether the stock is undervalued or overvalued.

Additionally, the Graham Number is most suitable for stable and mature companies with predictable earnings and a strong balance sheet. It may not be as effective for evaluating high-growth or technology companies, which often have different valuation metrics.

Graham Number Formula

The Graham Number is a financial metric that was developed by Benjamin Graham, a renowned investor and author of the book “The Intelligent Investor.” It is a valuation method used to determine the fair value of a stock based on its earnings and book value.

Definition

The Graham Number formula is calculated by multiplying the earnings per share (EPS) by the book value per share (BVPS) and taking the square root of the result:

Graham Number = √(EPS * BVPS)

The EPS represents the company’s profitability, while the BVPS represents the company’s net worth. By combining these two factors, the Graham Number provides investors with an estimate of the intrinsic value of a stock.

Example

Let’s say Company XYZ has an EPS of \$2.50 and a BVPS of \$20. Using the Graham Number formula, we can calculate the fair value of the stock:

Graham Number = √(2.50 * 20) = √50 = \$7.07

Therefore, according to the Graham Number, the fair value of Company XYZ’s stock is \$7.07 per share.

Limitations

While the Graham Number can be a useful tool for investors, it does have its limitations. It is important to note that the Graham Number is a simplified valuation method and should not be the sole basis for making investment decisions.

Graham Number Example and Limitations

The Graham Number is a financial metric used to evaluate the fair value of a stock. It was developed by Benjamin Graham, a renowned investor and author of “The Intelligent Investor.” The Graham Number is calculated by multiplying the earnings per share (EPS) and book value per share (BVPS) of a company and taking the square root of the result.

For example, let’s consider a company with an EPS of \$2.50 and a BVPS of \$20. The Graham Number would be calculated as follows:

Graham Number = √(EPS * BVPS) = √(2.50 * 20) = √50 = 7.07

Additionally, the Graham Number may not be suitable for all types of companies. It is more commonly used for stable, mature companies with consistent earnings and book values. For companies in high-growth industries or with volatile earnings, alternative valuation methods may be more appropriate.