The Graham number, invented by the godfather of value investing Benjamin Graham, came about as a way of calculating the fair value of a stock. If the current share price is under the calculated Graham number, then the stock is cheap and can be brought as a value investment. However, if the stock is trading above the Graham number then the stock is expensive and should be sold.
The Graham Number calculation requires that a stock should not be trading on a P/E greater than 15 and P/B value of more than 1.5. If the P/B ratio is greater than 1.5 then the assets of the company are selling at too much of a premium.
However, this ratio does leave out many fundamental factors and could be unsuitable for many large and medium cap stocks. Nevertheless, it is a good starting point for screening value investment possibilities.
Graham Number = Square Root of (22.5 x Book Value Per Share x Earnings Per Share)
The square root of 22.5 signifies Graham's belief that the P/E ratio should not be greater than 15 and the P/B no greater than 1.5 (15*1.5=22.5).
So to begin with, I screened the S&P 500 for stocks trading on a P/B of less than 1 and a P/E of less than 15. I then removed all of the financial stocks, as I believe book values of financial stocks can be unreliable. After I had used all the stocks trading under a P/B of 1, I then screened for stocks with the P/B value of greater than 1.
Here are the results, ranked in order of the biggest discount to the Graham Number.
1. Cliffs Natural Resources (NYSE:CLF) Share Price: $35.6
- P/E - 5.56
- P/B - 0.8
- EPS - 6.4
- Book Value Per Share - $44.50
- Graham Value = SQRT(22.5*6.4*44.50) = $80.05
- Current discount = 55.53%
Operating within the Industrial Metals and Minerals Sector, Cliffs can be highly volatile with a Beta of 2.4, although the significant discount to the Graham value does offer significant upside potential.
2. Xerox Corp. (NYSE:XRX) Share Price: $6.7
- P/E - 7.52
- P/B - 0.7
- EPS - 0.9
- Book Value Per Share - $9.84
- Graham Value = SQRT(22.5*0.9*9.84) = $14.11
- Current discount = 52.60%
Operating within the Information Technology and Services Sector, Xerox presents a less volatile option than Cliff's with a Beta of 1.6. The company also offers a significant discount to its Graham value at current levels.
3. Hess Corp. (NYSE:HES) Share Price: $51.3
- P/E - 11.5
- P/B - 0.58
- EPS - 4.5
- Book Value Per Share - $88.45
- Graham Value = SQRT(22.5*4.5*88.45) = $94.21
- Current discount = 45.55%
Operating within the Oil & Gas Refining & Marketing Sector, Hess has the lowest volatility so far, with a beta of 1.24. The company also currently offers a significant a margin of safety with a 45.6% discount to its Graham value.
4. Corning Inc. (NYSE:GLW) Share Price: $12.5
- P/E - 9.8
- P/B - 0.85
- EPS - 1.3
- Book Value Per Share - $14.71
- Graham Value = SQRT(22.5*1.3*14.71) = $20.74
- Current discount = 39.73%
Operating within the Diversified Electronics Sector, Corning has a beta of 1.4. The company currently offers a prospective upside of 39.73%.
5. CME Group Inc. (NASDAQ:CME) Share Price: $50.12
- P/E - 11.26
- P/B - 0.77
- EPS - 4.45
- Book Value Per Share - $65.10
- Graham Value = SQRT(22.5*4.45*65.10) = $80.73
- Current discount = 37.92%
Operating within the Investment Brokerage - National Sector, the CME group has a beta of 1.12. The company currently offers a prospective upside of 37.9%.
6. Nasdaq OMX Group Inc. (NASDAQ:NDAQ) Share Price: $25
- P/E - 12.5
- P/B - 0.8
- EPS - 2
- Book Value Per Share - $31.13
- Graham Value = SQRT(22.5*2*31.13) = $37.42
- Current discount = 33.47%
Operating within the Diversified Investments Sector, Nasdaq OMX Group has a low beta of 0.85. The company also currently offers a 33.47% discount to its Graham value.
7. Leucadia National Corp. (NYSE:LUK) Share Price: $23.5
- P/E - 11.34
- P/B - 0.93
- EPS - 2.07
- Book Value Per Share - $25.27
- Graham Value = SQRT(22.5*2.07*25.27) = $34.41
- Current discount = 31.50%
Operating within the Conglomerates Sector, Leucadia National has a relatively high beta of 1.8. The company also offers a relatively large 31.5% discount to its Graham value.
8. Apache Corp. (NYSE:APA) Share Price: $77.05
- P/E - 12.3
- P/B - 0.98
- EPS - 6.25
- Book Value Per Share - $78.62
- Graham Value = SQRT(22.5*6.25*78.62) = $105.15
- Current discount = 26.72%
Operating within the Independent Oil and Gas Sector, Apache Corp. has a beta of 1.3. The company currently offers one of the smaller discounts to itS Graham value with the current price offering a 26.7% discount.
9. Molson Coors Brewing Company (NYSE:TAP) Share Price: $42.7
- P/E - 14
- P/B - 0.94
- EPS - 3.05
- Book Value Per Share - $45.43
- Graham Value = SQRT(22.5*3.05*45.43) = $55.83
- Current discount = 23.5%
Operating within the Brewers Sector, Molson Coors has the lowest beta in the group at 0.75. The company currently offers 23.5% discount to its Graham value.
10. Tyson Foods Inc. (NYSE:TSN) Share Price: $19.2
- P/E - 12.14
- P/B - 1.15
- EPS - 1.6
- Book Value Per Share - $16.70
- Graham Value = SQRT(22.5*1.6*16.70) = $24.52
- Current discount = 21.7%
Operating within the Meat Products sector, Tyson Foods has the lowest beta in the group of around 1. The company also offers the smallest discount to its Graham value in the group; currently only offering a 21.7% discount.
Data Source: FINVIZ