Thursday, September 30, 2010

Graham Number

I thought today I would talk about the Graham Price or Graham Number as there has been questions about this item. This is based on the principles of Benjamin Graham and it is meant to be used to calculate the maximum price you should pay for a stock. The Dividends Matters website has a tutorial on this subject.

Benjamin Graham wrote a book called The Intelligent Investor and this book is considered to be a classic investment book. On my website, you can find out how to order this book on Amazon if you care to purchase it. See Graham. Also, this book review and other books I have reviewed are on my website at Book Reviews. Benjamin Graham has an entry on Wikipedia. There is also a good review of this book at Motley Fool website.

Why do I look at this number? I want to be able to figure out what a decent price is to pay for a stock. To this end, I not only look at the Graham Number, but also P/E (price/earnings) ratios, P/B (Price/Book Value) ratios and dividend yield. That is why I look at the current ratios, the dividend yield and the Graham Price and compare them to 5 and 10 year averages.

Having invested for many years, I doubt if you can do better than pay a rather average price for a stock. What I am trying to prevent is over paying for a stock. What I have found is that if you over pay for a stock, the dividend yield that you get over the long term can be affected. If you do this too much, I am sure your portfolio will also suffer.

The formula I use is the square root of (22.5 X EPS X BVPS), where EPS is earnings per share and BVPS is Book Value per share. When I am calculating the current Graham Price, I simply use in my formula, the estimate earnings for the current year and the current book value (all from my spreadsheet).

For other years, in the Graham Prices on my spreadsheet I use the diluted reported earnings per share. There is some controversy about what you should use. Some think that you should use net earnings divided by the outstanding shares. I find mostly that there is not much difference and I want a quick and easy way to get a value to match against the current price.

Some site talks about the NCAV (or net current asset value) and have a formula for that, but I do not use this figure. For a discussion on this aspect of Graham’s way of investing, see Daniel Libeskind’s site.

I am not the only blogger who talks about Graham’s methods for valuing stocks. See Stingy Investor’s blog. See Dividend Matters site again for how a company such as Saputo (TSX-SAP) is valued. Also, see the Div-Net site on how they use the Graham Price in valuing Lowes Company (NYSE-LOW). There is also the site that explains how they use Benjamin Graham Number to determine a fair price to pay for a stock.

This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. See my website for stocks followed and investment notes. Follow me on twitter.

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