Benjamin Graham, known as the "Father of Value Investing," invented the Graham number. This value is used to determine the stock's fair value in securities investment. It's calculated by taking the financial figures of Earnings Per Share and Book Value Per Share (BVPS).Theoretically the Graham number represents the highest price a defensive investor should pay for a stock.
It is deemed beneficial if the stock price is less than the Graham Number. As per Graham's philosophy, companies can uncover undervalued prospects by thoroughly reviewing their financial statements.
The formula to derive Graham Number
GAIL (India) Ltd. reported EPS as Rs. 21.08 and BVPS (Book Value Per Share) of Rs. 119.99.
The value as per the formula [( √15 x 1.5 x EPS TTM x BVPS) or ( √22.5 x EPS TTM x BVPS)] is calculated as (√15 x 1.5 x 13.82 x 119.99) = 238.56
Gail India Limited is currently trading at a lower price than Graham Number. So as per Graham Number, it indicates that it is undervalued.
If a company's Price to Earnings (PE) ratio is under 15 and its Price to Book (PB) ratio is under 1.5, then the Graham number is effective. And if a company's price to earning ratio is above 15 and its price to book ratio above 1.5 then the graham number may not be that effective. Hence ben graham took pe ratio 15 and pb ratio 1.5 in his graham number formula.
Price to Graham Number
Price to Graham number is a version of Graham number that compares the company's current stock price with its graham number. It indicates the highest price of the stock that an investor should pay for the company's stock. It is calculated by dividing the current stock price by Graham Number.
The formula to derive Price to Graham Number
As shown above, Gail India limited's Graham Number is 238.56, and its current stock price is Rs. 139.65. The value as per the formula (Price / Graham Number) is calculated as (139.65 / 280.94) = 0.58.
How to use Graham Number
Graham number indicates whether the stock is trading at fair value or not. In other words, it shows whether the stock is undervalued or overvalued. If a company's stock is trading at a high price compared to the graham number, then it indicates that it is overvalued. Contrary to this, if the company's stock is trading at a low price compared to the Graham number, then it is undervalued. While looking at the Graham Number, always analyze companies that have PE Ratio below 15 and Price to Book ratio below 1.5 as it is more effective for this criteria.
• PE Ratio-
It measures the relationship between the company's current stock price and EPS (Earnings Per Share). It is one of the important parameters to evaluate whether a company's stock price is overvalued or undervalued.
The PE ratio is the most popular and well-known valuation metric used by many investors to analyze whether the stock is overvalued or undervalued. It indicates how much investors are willing to pay for a stock's current price to earn one rupee.
• Price to Book Ratio-
Price to book value essentially determines the value given by the market for each rupee of the company's net worth. Book value refers to how much an investor would receive if the company sold off its assets and paid all its debts. Book value shows the actual value of the company.
This ratio is calculated by Current Price divided by Book Value Per Share. This metric helps to understand whether the company is overvalued or undervalued.
• EPS (TTM)-
It is the abbreviation for Earnings Per Share Trailing Twelve Months.
Earnings Per Share (EPS) TTM Ratio is a valuation metric that measures how much money a company makes on a per share basis. EPS is calculated as net income divided by weighted share outstandings. This metric indicates the company's ability to generate net profits for common shareholders.
• Book Value Per Share (BVPS)-
It indicates the company's net assets value on a per share basis. The formula to calculate Book Value Per Share (BVPS) is (Total Assets - Total Liabilities / Total Outstanding Shares).
Benjamin Graham was an American economist, professor, and investor. He was born in the United Kingdom and is widely regarded as the "Father of Value Investing." Benjamin Graham published his first book in 1934 with David Dodd, which was entitled: Security Analysis, and another book in 1949 is entitled: The Intelligent Investor. Benjamin Graham explains his investment philosophy and what a value investor is in both of his books. Along with his work in investment finance, Benjamin Graham also contributes to economic theory. He has led a current wave of value investing in hedge funds, diversified holding companies, mutual funds, and other ventures through his work in management economics and investing. He accomplished it by receiving the title of Salutatorian from Columbia University when he was 20 years old, a distinction given to the second-ranked graduate of all graduates in the United States. Because of his outstanding performance, he was given a position as a faculty member at Columbia University, where he would teach Mathematics, English, and Philosophy. On the other hand, he wanted to work for a Wall Street brokerage company called Newburger, Henderson & Loeb.
Investors should use a Graham number to analyze companies that have a P/E ratio below 15 and a PB ratio below 1.5. Always look for companies that are trading lower compared to the graham number. Stocks of companies that trade at a higher price than a Graham Number are considered overvalued as per the Graham number.