Graham Number: Definition, Formula, Example, and Limitations

What Is the Graham Number?

The Graham number (or Benjamin Graham's number) measures a stock's fundamental value by taking into account the company's earnings per share (EPS) and book value per share (BVPS).

The Graham number is the upper bound of the price range that a defensive investor should pay for the stock. According to the theory, any stock price below the Graham number is considered undervalued and thus worth investing in.

Understanding the Graham Number

The Graham number is named after the "father of value investing," Benjamin Graham. It is used as a general test when trying to identify stocks that are currently selling for a good price. The 22.5 figure is included in the calculation to account for Graham's belief that the price-to-earnings (P/E) ratio should not be over 15x and the price-to-book ratio should not be over 1.5x (thus, 15 x 1.5 = 22.5).

The Graham number can thus be alternatively calculated as:

$\sqrt{15\ \times\ 1.5\ \times\ \left(\frac{\text{net income}}{\text{shares outstanding}}\right)\ \times\ \left(\frac{\text{shareholders' equity}}{\text{shares outstanding}}\right)}$15 × 1.5 × (shares outstandingnet income​) × (shares outstandingshareholders’ equity​)​

Essentially, this second method of calculation is equivalent to the first, wherein EPS = net income/shares outstanding, and book value is another term for shareholders’ equity.

The Formula for Graham Number

$\sqrt{22.5\ \times\ \text{(earnings per share)}\ \times\ \text{(book value per share)}}$22.5 × (earnings per share) × (book value per share)​

Where:

• Earnings per share (EPS) is calculated as a company's net profit divided by the number of outstanding shares of its common stock.
• Book value per share (BVPS) is the ratio of equity available to common shareholders divided by the number of outstanding shares. This figure represents the minimum value of a company's equity and measures the book value of a firm on a per-share basis.

Example of the Graham Number

For example, if the earning per share for a single share of company ABC is $1.50, the book value per share is $10, the Graham number would be 18.37. ((22.5*1.5*10)^1/2= 18.37). Again, $18.37 is the maximum price an investor should pay for a share of ABC, according to Graham. If ABC is priced at $16, it is attractive; if priced at $19, it should be avoided.

Limitations of the Graham Number

The calculation for the Graham number does leave out many fundamental characteristics, which are considered to comprise a good investment, such as management quality, major shareholders, industry characteristics, and the competitive landscape.

With regard to stocks and equity instruments, fundamental analysis is a method of determining the value that focuses on key metrics and economic indicators, such as revenues, earnings, where an industry is in its cycle, return on equity (ROE), and profit margins.

Fundamental analysis relies on a company’s financial statements. One of the most famous and successful fundamental analysts, Warren Buffett—aka "the Oracle of Omaha"—is famous for successfully employing fundamental analysis. Warren Buffett was both a student and employee of Benjamin Graham. The fundamental method of security analysis is considered to be the opposite of technical analysis.

The Bottom Line

The Graham number measures a stock's fundamental value by taking into account the company's EPS and BVPS. It represents the upper bound of the price range that a defensive investor should pay for a stock, and it suggests that any stock price below the Graham number is undervalued and thus worth investing in.

Correction—March 21, 2024: This article has been corrected to state Graham's belief that the price-to-book ratio should not be over 1.5x.