Calculators

Graham's Number

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Who Was Benjamin Graham?

Benjamin Graham was a professor, economist, and investor born in England, known for his significant contributions to the theories of Value Investing, as well as being a mentor to Warren Buffet.

Graham's thought process is described in his two main books, The Intelligent Investor and Security Analysis. Although some concepts in these books are outdated, many topics have proven to be enduring and are used by prominent investors to this day, such as long-term thinking and risk profile analysis.

What Is the Graham Number?

The Graham Number is a simple ratio that Benjamin Graham determined as fair when considering a company's price.

By applying this ratio in a formula along with the current values of a company, we can determine the intrinsic value, that is, the price that Graham considered fair for a stock with those indicators: Loading...

In this formula, we have the following variables:

Additionally, you can see the constant 22.5, which is nothing more than the multiplication of the indicators Graham considered fair for a company, which are P/E Ratio = 15x and P/B Ratio = 1.5x (15 * 1.5 = 22.5).

How Does the Graham Number Formula Work?

To understand the formula, let's start with the constant defined by Graham: Loading...

What we have here is a ratio involving three variables:

Of these variables, we want to isolate P, and we already know the Earnings and Book Value of the company, just by looking at the current data. So, we can move both E and B to the other side and multiply the two remaining P's: Loading...

To finish isolating P, we can take the square root of both sides: Loading...

And there you have it! We have the fair market value for the company. As we want to know the price per share, and we have the total value, we need to divide it by the number of outstandig shares, which we'll call N: Loading...

Where P/N is what we initially called Price. Now, to include N inside the square root, we square it as well: Loading...

If we separate the two N's and use one as a divisor for E and the other as a divisor for B, we get the Earnings Per Share (EPS) and the Book Value Per Share (BPS), respectively: Loading...

And thus, we return to the formula created by Benjamin Graham.

What Is the Purpose of the Graham Number?

As mentioned earlier, the Graham Number is a ratio suggested by Graham of 15x the company's Earnings and 1.5x its Book Value. Therefore, being below these multiples indicates a stock that he would consider "cheap" in the stock market, meaning a stock is being traded below its intrinsic value.

Using the formula, we can calculate the fair price, and if the current price is below the fair price, we can calculate the Upside. The Upside of a stock is essentially its potential for appreciation according to Graham:

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However, the stock market does not necessarily operate this way. There are stocks that are traded at an average historical ratio below or above this proportion, either due to market skepticism or other factors. This doesn't mean that the stock will at some point be traded at the suggested ratio.

Thus, the Graham Number can be considered a technique for stock screening, where we can immediately separate stocks that we consider "expensive". However, it should never be used as the sole or decisive factor when making an investment. After segregating these assets that can comprise your investment portfolio, you also need to consider other factors, such as non-recurring effects, predictions for that segment, and the overall macroeconomy.

After all, investing is about this: we cannot rely on a single indicator; we have to study various factors and look at the market as a whole.

Practical Examples

Below, we'll see some examples of applying the Graham Number and precautions to take when using it. All values were taken on March 4, 2022.

ISRG:

Intuitive Surgical Inc. (ISRG) is a leading manufacturer of robotic surgical systems. As of the 2Q2023, Intuitive Surgical had an EPS (Earnings Per Share) of $3.98 and a BVPS (Book Value Per Share) of $34.04.

Using the formula:

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At the same period, the stock price was around $341, which could mean that the company is overpriced.

However, the company is highly growth-oriented, and as a result, the market prices the stock with future growth potential in mind. This explains, for example, the company's P/E skyrocketing from 16x in 2019 to over 70x in 2021 and 2022.

GM:

General Motors Company (GM) is a well-known American multinational corporation that manufactures vehicles and provides automotive services. If we consider the end of 2022, GM had an EPS (Earnings Per Share) of $6.37 and a BVPS (Book Value Per Share) of $48.42.

Using the formula:

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At the same period, the stock price was around $33.64, which could mean that the company is underpriced, with a potential upside of 148%.