In the search for potentially undervalued stocks, one method comes from the “godfather of value investing,” Benjamin Graham. Graham was an author, professor, and former mentor of Warren Buffett.
Graham created an equation that calculates the fair value of stocks based on two fundamental 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.
Using this equation, we screened for potentially undervalued stocks among the universe of those with 5-year projected EPS growth above 20%. These stocks are also rallying above their 20-day, 50-day, and 200-day moving averages.
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the 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.
Do you think these stocks will rise to their Graham fair value? Use this list as a starting-off point for your own analysis.
List sorted by potential upside implied by Graham number.
1. Multimedia Games Inc. (MGAM): Engages in the development and supply of comprehensive systems, content, electronic games, and player terminals for the casino, charity, international bingo, and video lottery markets in the United States and Internationally. Market cap of $155.61M. Estimated EPS growth over the next 5 years at 30.0%. The stock is currently trading at 27.87% above its 20-Day SMA, 27.99% above its 50-Day SMA, and 14.27% above its 200-Day SMA. TTM Diluted EPS at $0.50, MRQ Book Value Per Share at $4.22, Graham number at $6.89 (vs. current price at $5.80, implies a potential upside of 18.80%). The stock is a short squeeze candidate, with a short float at 5.09% (equivalent to 9.65 days of average volume). The stock has had a couple of great days, gaining 6.75% over the last week.
2. Standard Motor Products Inc. (SMP): Distributes replacement parts for motor vehicles in the automotive aftermarket industry primarily in the United States, Canada, and Latin America. Market cap of $346.55M. Estimated EPS growth over the next 5 years at 21.30%. The stock is currently trading at 8.44% above its 20-Day SMA, 16.45% above its 50-Day SMA, and 13.53% above its 200-Day SMA. TTM Diluted EPS at $1.40, MRQ Book Value Per Share at $10.36, Graham number at $18.06 (vs. current price at $15.27, implies a potential upside of 18.30%). This is a risky stock that is significantly more volatile than the overall market (beta = 2.31). The stock has had a good month, gaining 11.65%.
3. Lithia Motors Inc. (LAD): Operates as an automotive franchisee and retailer of new and used vehicles. Market cap of $480.28M. Estimated EPS growth over the next 5 years at 26.0%. The stock is currently trading at 11.54% above its 20-Day SMA, 8.54% above its 50-Day SMA, and 10.04% above its 200-Day SMA. TTM Diluted EPS at $1.41, MRQ Book Value Per Share at $12.99, Graham number at $20.30 (vs. current price at $17.24, implies a potential upside of 17.75%). The stock is a short squeeze candidate, with a short float at 15.39% (equivalent to 7.8 days of average volume). The stock has gained 82.19% over the last year.
*BVPS and EPS data sourced from Yahoo! Finance, all other data sourced from Finviz. Data sourced Oct 19.