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One method of searching for potentially undervalued stocks is using an equation created by none other than the “godfather of value investing” Benjamin Graham. Graham was a former mentor to Warren Buffett, whom he taught at Columbia Business School.

The equation calculates what is known as the “Graham number,” which is the maximum fair value for a stock. Any stock trading at a significant discount to this number is considered undervalued by the equation.

The Graham Number only requires two data points: current earnings per share and current book value per share. 
The Graham Number = Square Root of (22.5) x (TTM Earnings per Share) x (MRQ Book Value per Share). 

This equation assumes that a stock is overvalued if P/E is over 15 or P/BV is over 1.5.

We used this equation to screen for potentially undervalued stocks among the universe of stocks in the S&P 500 that pay dividend yields above 2% and sustainable payout ratios below 50%.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the top six stocks mentioned below. Analyst ratings sourced from Zacks Investment Research.

We also created a price-weighted index of the stocks mentioned below, and monitored the performance of the list relative to the S&P 500 index over the last month. To access a complete analysis of this list's recent performance, click here.


(Click to enlarge)

Do you think these stocks are undervalued? Use this list as a starting-off point for your own analysis.

List sorted by potential upside implied by the Graham number.

1. Carnival Corporation (NYSE:CCL): Operates as a cruise and vacation company. Market cap of $23.42B. Dividend yield at 3.26%, payout ratio at 34.51%. TTM Diluted EPS at $2.45, MRQ Book Value Per Share at $31.65, Graham number at $41.77 (vs. current price at $30.00, implies a potential upside of 39.23%). It's been a rough couple of days for the stock, losing 7.73% over the last week.

2. Sealed Air Corporation (NYSE:SEE): Manufactures and sells packaging and performance-based materials and equipment systems worldwide. Market cap of $2.50B. Dividend yield at 3.17%, payout ratio at 33.59%. TTM Diluted EPS at $1.42, MRQ Book Value Per Share at $16.08, Graham number at $22.67 (vs. current price at $16.45, implies a potential upside of 37.79%). It's been a rough couple of days for the stock, losing 12.7% over the last week.

3. General Dynamics Corp. (NYSE:GD): Provides business aviation, combat vehicles, weapons systems and munitions, military and commercial shipbuilding, and communications and information technology products and services worldwide. Market cap of $20.14B. Dividend yield at 3.29%, payout ratio at 24.79%. TTM Diluted EPS at $7.01, MRQ Book Value Per Share at $38.49, Graham number at $77.92 (vs. current price at $56.79, implies a potential upside of 37.20%). Might be undervalued at current levels, with a PEG ratio at 0.9, and P/FCF ratio at 8.67. The stock has performed poorly over the last month, losing 11.77%.

4. Harris Corp. (NYSE:HRS): Operates as a communications and information technology company that serves government and commercial markets worldwide. Market cap of $3.94B. Dividend yield at 3.27%, payout ratio at 21.54%. TTM Diluted EPS at $4.60, MRQ Book Value Per Share at $20.32, Graham number at $45.86 (vs. current price at $33.71, implies a potential upside of 36.04%). Might be undervalued at current levels, with a PEG ratio at 0.75, and P/FCF ratio at 10.34. The stock is a short squeeze candidate, with a short float at 12.61% (equivalent to 9.23 days of average volume). It's been a rough couple of days for the stock, losing 8.41% over the last week.

5. AFLAC Inc. (NYSE:AFL): Provides supplemental health and life insurance. Market cap of $15.68B. Dividend yield at 3.32%, payout ratio at 30.74%. TTM Diluted EPS at $3.80, MRQ Book Value Per Share at $25.65, Graham number at $46.83 (vs. current price at $34.75, implies a potential upside of 34.76%). Might be undervalued at current levels, with a PEG ratio at 0.73, and P/FCF ratio at 2.01. The stock has lost 33.14% over the last year.

6. BlackRock, Inc. (NYSE:BLK): Provides its services to institutional, intermediary, and individual investors. Market cap of $25.39B. Dividend yield at 3.74%, payout ratio at 23.76%. TTM Diluted EPS at $12.27, MRQ Book Value Per Share at $136.38, Graham number at $194.04 (vs. current price at $144.25, implies a potential upside of 34.52%). The stock is currently stuck in a downtrend, trading 8.95% below its SMA20, 12.82% below its SMA50, and 24.29% below its SMA200. It's been a rough couple of days for the stock, losing 5.71% over the last week.

7. The Washington Post Company (WPO): Operates as a diversified education and media company in the United States and internationally. Market cap of $2.49B. Dividend yield at 2.94%, payout ratio at 33.94%. TTM Diluted EPS at $24.07, MRQ Book Value Per Share at $341.53, Graham number at $430.07 (vs. current price at $319.91, implies a potential upside of 34.44%). The stock is a short squeeze candidate, with a short float at 9.24% (equivalent to 12.03 days of average volume). The stock has lost 20.48% over the last year.

8. Chevron Corp. (NYSE:CVX): Engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. Market cap of $180.03B. Dividend yield at 3.41%, payout ratio at 25.66%. TTM Diluted EPS at $11.45, MRQ Book Value Per Share at $57.74, Graham number at $121.96 (vs. current price at $91.03, implies a potential upside of 33.98%). The stock is currently stuck in a downtrend, trading 8.1% below its SMA20, 9.78% below its SMA50, and 11.5% below its SMA200. The stock has gained 14.1% over the last year.

9. Entergy Corporation (NYSE:ETR): Operates as an integrated energy company in the United States. Market cap of $11.49B. Dividend yield at 5.16%, payout ratio at 46.76%. TTM Diluted EPS at $7.06, MRQ Book Value Per Share at $48.62, Graham number at $87.88 (vs. current price at $65.67, implies a potential upside of 33.82%). The stock has lost 11.6% over the last year.

10. Time Warner Inc. (NYSE:TWX): Operates as a media and entertainment company in the United States and internationally. Market cap of $30.26B. Dividend yield at 3.13%, payout ratio at 35.96%. TTM Diluted EPS at $2.32, MRQ Book Value Per Share at $30.15, Graham number at $39.67 (vs. current price at $29.87, implies a potential upside of 32.81%). It's been a rough couple of days for the stock, losing 5.82% over the last week.

11. Avery Dennison Corporation (NYSE:AVY): Produces pressure-sensitive materials, office products, tickets, tags, labels, and other converted products. Market cap of $2.54B. Dividend yield at 3.94%, payout ratio at 32.08%. TTM Diluted EPS at $2.78, MRQ Book Value Per Share at $17.05, Graham number at $32.66 (vs. current price at $24.95, implies a potential upside of 30.89%). It's been a rough couple of days for the stock, losing 8.58% over the last week.

12. The Dow Chemical Company (NYSE:DOW): Manufactures and supplies products used as raw materials in the production of customer products and services worldwide. Market cap of $25.41B. Dividend yield at 4.39%, payout ratio at 31.29%. TTM Diluted EPS at $2.18, MRQ Book Value Per Share at $17.09, Graham number at $28.95 (vs. current price at $22.15, implies a potential upside of 30.71%). This is a risky stock that is significantly more volatile than the overall market (beta = 2.31). It's been a rough couple of days for the stock, losing 11.37% over the last week.

13. Sempra Energy (NYSE:SRE): Engages in the development of energy infrastructure, operation of utilities, and provision of energy-related products and services worldwide. Market cap of $11.94B. Dividend yield at 3.86%, payout ratio at 35.42%. TTM Diluted EPS at $4.85, MRQ Book Value Per Share at $40.01, Graham number at $66.08 (vs. current price at $51.03, implies a potential upside of 29.49%). The stock has lost 3.86% over the last year.

14. Staples, Inc. (NASDAQ:SPLS): Operates as an office products company. Market cap of $9.07B. Dividend yield at 3.02%, payout ratio at 36.27%. TTM Diluted EPS at $1.30, MRQ Book Value Per Share at $10.02, Graham number at $17.12 (vs. current price at $13.24, implies a potential upside of 29.30%). Might be undervalued at current levels, with a PEG ratio at 0.72, and P/FCF ratio at 11.18. The stock is currently stuck in a downtrend, trading 7.98% below its SMA20, 10.17% below its SMA50, and 29.61% below its SMA200. The stock has performed poorly over the last month, losing 10.68%.

15. Edison International (NYSE:EIX): Engages in the supply of electric energy in central, coastal, and southern California. Market cap of $12.09B. Dividend yield at 3.53%, payout ratio at 39.39%. TTM Diluted EPS at $3.20, MRQ Book Value Per Share at $32.92, Graham number at $48.69 (vs. current price at $37.70, implies a potential upside of 29.14%). The stock has gained 10.64% over the last year.

*EPS and BVPS data sourced from Yahoo! Finance, all other data sourced from Finviz.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: 15 S&P 500 Dividend Stocks Undervalued By The Graham Number