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Graham Number – Defined

The Graham number (not to be confused with Graham’s Number in mathematics) attempts to find the fair value or the maximum price that an investor can pay for a particular stock by taking Earnings per Share (EPS) and Book value per share (BV/Share) into consideration. Any price below the Graham Number is considered to be the fair value for an investor to invest in.

Benjamin Graham

Benjamin Graham is one of the founding fathers of value investing. He was the proponent of the ideology to read the Company’s Financial statements and finding the fair value of the stock. He was the mentor to many successful investors including Warren Buffet. His books namely “The Intelligent Investor” and “The Interpretation of Financial Statements” are considered to be the foundation of value investing.

The Formula for Graham Number

Graham Number = √22.5 * (Earnings per Share)*(Book Value per Share)

Where

Earnings per Share = Net Income  ÷ Outstanding Number of Shares

book Value per Share = Shareholder’s Equity ÷  Outstanding Number  of Shares

The Number 22.5 is based on Graham’s belief that the Price to Earnings Ratio shall not be more than 15x and Price to Book ratio shall not be more than 1.5x.

Therefore , (15x) * (1.5x) = 22.5

Alternatively, the formula can also be represented as,

Graham Number = √15 * 1.5* (Net Income  ÷ Outstanding Number of Shares ) * (Shareholder’s Equity ÷  Outstanding Number  of Shares)

For Example,

If the EPS of an XYZ Stock is 5 and Book Value Per Share is 10 then the Graham Number is 1125. So, the maximum price that an investor can pay for the XYZ Stock is 1125. Any price below Rs.1125 is a fair value for investing.

Limitation of the Graham Number

Graham Number does not take the most important factors such as Management, broad market scenario, competitive edge, etc., and sticks only to the financials of the company.

Using the Graham Number

Graham Number cannot be solely relied upon for the analysis of a stock as it does not take many factors into account. However, it can be added as a valuable tool in the kitty of a Value Investor.

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