Value investing is essentially the pursuit of stocks that are currently trading below their true value. The stock is purchased and then held until the value of the company's true value is realized. One common method investors can use to calculate the stock's fair value is the Graham number. In theory the Graham number is the maximum price a value investor should pay, any price below the Graham number is considered to be a good value and any price above and the stock should be sold. While this method is commonly used and cited it should not be used by itself in stock selection.
The Graham number is calculated by taking the square root of 22.5*TTM EPS*BV. 22.5 is used to account for Graham's belief that a stock's price-to-earnings ratio should never be above 15 and its price-to-book value should never be above 1.5 (15*1.5= 22.5).
Below are five companies that are currently undervalued as represented by their Graham number. As mentioned this calculation should never be used as the sole criteria to purchase a stock, but rather a starting point for further due diligence.
Reinsurance Group of America Inc. (RGA) is a leader in the global life reinsurance industry with approximately $2.9 trillion of life reinsurance in force and assets of $40.4 billion. With operations in 25 countries it is one of the largest reinsurance companies in the world. The company currently has a market cap of $4.25 billion and an enterprise to EBITDA ratio of 2.66. With TTM EPS of $8.53 and a current book value of 93.47, RGA has a Graham number of $133.86. The stock is currently trading at approximately $57.50, representing a significant discount to the company's fair value based on the Graham calculation.
Reliance Steel & Aluminum Co. (RS) is the largest metals service center company in North America. The company has a network of over 220 locations in 38 states and 10 different countries in Europe, Asia and Latin America, providing value-added metals processing services and distributing more than 100,00 metal products. Reliance currently has a market cap of $5.0 billion and an enterprise to EBITDA ratio of 7.48. Given the company's book value of $46.79 and TTM EPS of $5.33, RS's fair value is calculated at $74.91 representing a discount of almost 14% to the stock's current price of approximately $65.75.
Universal Corp (UVV) is the world's leading leaf tobacco merchant and processor based on volumes handled by its subsidiaries and has operations in agri-products. The company conducts business in more than 30 countries employing over 24,000 permanent and seasonal workers. UVV has an enterprise to EBITDA ratio 6.0 and a market cap of $1.3 billion. Universal Corp's TTM EPS of $4.65 combined with a book value of $44.37 give it a Graham number of $68.33 meaning the company is potentially undervalued by almost 23%.
Vale S.A. (VALE) is a Brazilian multinational diversified metals and mining corporation and one of the largest logistics operators in Brazil. With operations in 37 countries the company is the second-largest mining company in the world and the largest producer of iron ore, pellets, and second largest of nickel. Vale also produces manganese, ferroalloys, copper, bauxite, potash, kaolin, alumina and aluminum. In the electric energy sector, the company participates in consortia and currently operates nine hydroelectric plants. Vale is by far the largest company on this list with a market cap of $94.9 billion and an enterprise to EBITDA ratio of 5.5. Given the company's book value of $15.58 and TTM EPS of $2.28, Vale has a Graham number of $28.27 representing a premium of over 50% based on its current value of approximately $18.40 per share.
Ensco plc (ESV) is a multinational oil and gas services company with headquarters in London. It is the world's second-largest offshore oil and gas well drilling company, and has 49 offshore jack-ups, seven drillships and 20 semi-submersible drilling rigs. Ensco currently has an enterprise to EBITDA ratio of 8.37 and a market cap of $13.6 billion. The company has a Graham number of $76.37 given its book value of $51.53 and TTM EPS of $5.03. ESV is currently trading at $59.20, a discount of nearly 29% to its fair value as calculated by the Graham ratio.
Disclosure: I am long RGA.