The father of value investing
Benjamin Graham taught at Columbia Business School, mentored Warren Buffett and wrote two classics, Security Analysis (1934, with David Dodd) and The Intelligent Investor (1949). He insisted on buying stocks for less than they are worth, with a margin of safety against errors and bad luck. Two quick valuation rules carry his name.
The Graham number
For the defensive investor, Graham suggested paying no more than 15 times average earnings and no more than 1.5 times book value. Since 15 × 1.5 = 22.5, he allowed a trade-off: a P/E × P/B up to 22.5. The highest price that satisfies this rule is:
Graham number = √(22.5 × EPS × book value per share)
The Graham formula
For growth companies, Graham proposed in the 1962 edition of Security Analysis:
Value = EPS × (8.5 + 2g)
where g is the expected annual earnings growth over the next seven to ten years, in percent, and 8.5 the P/E he considered fair for a company with no growth. In 1974 he adjusted it for interest rates:
Value = EPS × (8.5 + 2g) × 4.4 ÷ Y
where 4.4% was the yield on AAA corporate bonds when he first proposed the formula, and Y is today’s AAA yield. Higher bond yields lower the value of stocks.
Worked example
A company earns $5.00 per share, has a book value of $30.00 per share, trades at $60 and is expected to grow earnings 7% a year, with AAA bonds yielding 4.4%:
- Graham number: √(22.5 × 5 × 30) = $58.09. The stock trades slightly above it.
- P/E = 12, P/B = 2.0, product 24, just above Graham’s limit of 22.5.
- Graham formula: 5 × (8.5 + 14) × 4.4 ÷ 4.4 = $112.50.
- Margin of safety versus the formula: (112.50 − 60) ÷ 112.50 = 46.7%.
How to use the numbers
- As a screen: stocks below their Graham number or well below their formula value deserve a closer look, not an automatic purchase.
- With conservative inputs: use average earnings over several years, and a modest growth rate. Graham warned that optimistic growth forecasts are the investor’s most dangerous enemy.
- With a margin of safety: Graham preferred to buy at a third or more below his estimate of value.
Limits
The formulas assume positive earnings and a meaningful book value. They undervalue businesses whose main assets, such as brands, software and patents, do not appear on the balance sheet, and they say nothing about debt, competition or management quality. Graham himself used them alongside many other tests: financial strength, a long dividend record and earnings stability.
This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.