Finance:Graham number

Short description: Calculated number representing the hypothetical value of a stock

Not to be confused with Benjamin Graham formula.

This page is about the investing term named after Benjamin Graham. For the large number named after Ronald Graham, see Graham's number.

The Graham number or Benjamin Graham number is a figure used in securities investing that measures a stock's so-called fair value. Named after Benjamin Graham, the founder of value investing, the Graham number can be calculated as follows:

$\sqrt{22.5\times (\text{earnings per share})\times (\text{book value per share})}$

The final number is, theoretically, the maximum price that a defensive investor should pay for the given stock. Put another way, a stock priced below the Graham Number would be considered a good value, if it also meets a number of other criteria.

The Number represents the geometric mean of the maximum that one would pay based on earnings and based on book value. Graham writes:

Current price should not be more than 1​¹⁄₂ times the book value last reported. However a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5. (This figure corresponds to 15 times earnings and 1​¹⁄₂ times book value. It would admit an issue selling at only 9 times earnings and 2.5 times asset value, etc.)

—Benjamin Graham, The Intelligent Investor, chapter 14

Alternative calculation

Earnings per share is calculated by dividing net income by shares outstanding. Book value is another way of saying shareholders' equity. Therefore, book value per share is calculated by dividing equity by shares outstanding. Consequently, the formula for the Graham number can also be written as follows:

$\sqrt{15\times 1.5\times \left(\frac{\text{net income}}{\text{shares outstanding}}\right)\times \left(\frac{\mathrm{s}\mathrm{h}\mathrm{a}\mathrm{r}\mathrm{e}\mathrm{h}\mathrm{o}\mathrm{l}\mathrm{d}\mathrm{e}\mathrm{r}{\mathrm{s}}^{\prime }\mathrm{e}\mathrm{q}\mathrm{u}\mathrm{i}\mathrm{t}\mathrm{y}}{\text{shares outstanding}}\right)}$

History

The Graham number was first mentioned in Benjamin Graham's famous 1949 book, The Intelligent Investor. Graham's defensive investment strategy mainly focused a "margin of safety" and reducing losses as opposed to maximizing gains. The Graham number was developed based on this concept to quickly value a stock.

Graham himself never gave a specific formula or equation. The Graham number was derived from guidelines he laid down in the book.

The Graham number is limited in its application as it does not take future growth into consideration making it unsuitable for growth stocks such as technology. Furthermore, the equation only works with positive earnings and book value making it useless for companies with negative earnings or equity.

See also

• Altman Z-score
• Beneish M-score
• Ohlson O-score
• Fundamental analysis
• Magic formula investing
• Value investing
• Benjamin Graham
• The Intelligent Investor
• Margin of Safety