Graham Number is a concept based on Ben Graham's conservative
valuation of companies. It calculates the intrinsic values of
companies based on its earnings per share and tangible book value
in a formula like this:
Graham Number = SquareRoot of (22.5 * Tangible Book Value per
Share* Earnings per Share)
= SquareRoot of (22.5 * Net Income* Total Equity) / {Total Shares
Outstanding
This is one of the ways to estimate the intrinsic value of
business based on their book value and their earnings power.
Ben Graham actually did not publish a formula like this. But he
wrote in The Intelligent Investor (1948 version) regarding to the
criteria for purchases:
"Current price should not be more than 15 times average earnings
of the past three years"
"Current price should not be more than 1.5 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 1.5 times book value. It
would admit an issue selling at only 9 times earnings and 2.5
times asset value, etc.)"
Unlike valuation methods such as DCF or Discounted Earnings, the
Graham number does not take growth into the valuation. Unlike the
valuation methods based on book value alone, it takes into
account the earnings power. Therefore, the Graham Number is a
combination of asset valuation and earnings power valuation.
In general, the Graham number is a very conservative way of
valuing a stock. It cannot be applied to companies with negative
book values.
We have added a new "Valuations" tab to the Guru Portfolio page,
which lists the companies in the portfolios of Gurus relative to
their Graham Number and other valuation methods such as Peter
Lynch Fair Value, Intrinsic Value (DCF Projected), value
indicated by median P/S etc.
Graham value is applicable only to the companies that have
positive earnings and positive tangible book value. These are the
companies in
Warren Buffett
's portfolio that Graham numbers are calculated:
|
Ticker
|
Company
|
Price
|
Graham Number
|
Discount
|
|
WPO
|
The Washington Post Company |
370.71 |
93.43 |
-297% |
|
MTB
|
M&T Bank Corporation |
80.8 |
82.05 |
2% |
|
TMK
|
Torchmark Corporation |
49.59 |
63.19 |
22% |
| LMCA |
Liberty Media Corp (Capital) |
86.9 |
44.7 |
-94% |
| WMT |
Wal-Mart Stores, Inc. |
68.3 |
39.26 |
-74% |
| WFC |
Wells Fargo & Company |
32.46 |
38.33 |
15% |
| JNJ |
Johnson & Johnson |
66.94 |
34.94 |
-92% |
| BK |
Bank Of Ny Mell |
21.04 |
21.2 |
1% |
| UPS |
United Parcel Service, Inc. |
77.13 |
21.1 |
-266% |
| KO |
The Coca-Cola Company |
76.59 |
13.83 |
-454% |
| GM |
General Motors Company |
19.8 |
11.92 |
-66% |
As we can see, as indicated by Graham Number, within Warren
Buffett's Portfolio, the companies that are undervalued are
M&T Bank Corporation (
MTB
), Torchmark Corporation (
TMK
), Wells Fargo & Company (
WFC
), and Bank Of Ny Mellon (
BK
). Companies such as UPS (
UPS
), Coca-Cola (
KO
), Johnson & Johnson (
JNJ
) and Washington Post (
WPO
) seems to be vastly overvalued.
Is this really the case?
Not necessarily. When applying any of those valuation methods,
you need to be aware of their limitations. Please keep these in
mind:
1. Graham Number does not take growth into account. Therefore it
underestimates the values of the companies that have good
earnings growth. We feel that if the earnings per share grows
more than 10% a year, Graham Number underestimates the value.
2. Graham Number punishes the companies that have temporarily low
earnings. Therefore, an average of earnings makes more sense in
the calculation of Graham Number.
3. Graham Numbers underestimates companies that are light with
book. Companies such as Moody's (
MCO
) and Dun & Bradstreet (
DNB
) has negative book values. Graham Number cannot be applied here.
As indicated in our announcement of New Feature Added: Valuation
Box, we also listed valuation methods such as Peter Lynch Fair
Value, Median P/S Value etc. They are also listed under the new
"Valuations" tab for gurus' portfolios. To learn more on how each
value is calculated, please read New Feature Added: Valuation Box
and How to calculate the intrinsic value of a stock?
We will continue to write about these and explain in more
details.
The new Valuation Tab is just one of the features we added to the
Premium features we continue to add to Premium Membership. If you
are not a Premium Member, why not take a 7-day Free Trial?
This is the link to the Valuation Tab of Warren Buffett's
Portfolio. You can check out all the valuation parameters
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