The Graham Number Formula Explained
The Graham Number is a simple yet powerful formula developed by Benjamin Graham to estimate the maximum price a defensive investor should pay for a stock. The formula is: Graham Number = √(22.5 × EPS × BVPS). This number represents the fair value of a stock based on its earnings and book value. If a stock trades below its Graham Number, it may be undervalued.
Why 22.5?
Graham believed that a stock with a P/E ratio above 15 was too risky for defensive investors, and a stock with a P/B ratio above 1.5 was too expensive. Multiplying these gives 22.5 (15 × 1.5 = 22.5). When applied to PSX stocks, we sometimes adjust this multiplier downward to 15-20 to account for Pakistan's higher interest rates and market volatility.
Worked Example
Take a company with EPS of Rs. 28.30 and book value per share of Rs. 98.15. Graham Number = √(22.5 × 28.30 × 98.15) = √62,496.6 ≈ Rs. 249.99. If its share price were Rs. 210, it would trade about 16% below its Graham Number. To try it on a real company, take its latest EPS and book value per share from its annual report and enter them in the Intrinsic Value Calculator.
A Second Example
A company with EPS of Rs. 28.60 and book value per share of Rs. 112.40 has a Graham Number of √(22.5 × 28.60 × 112.40) = √72,329.4 ≈ Rs. 268.94. At a price of Rs. 185 that is a margin of safety of about 31%; at Rs. 300 the price would be above the Graham Number and the stock would fail this screen.
Limitations of the Graham Number
The Graham Number is a rough filter, not a precise valuation tool. It doesn't consider growth rates, competitive advantages, or industry-specific factors. Companies in high-growth sectors or asset-light businesses may always trade above their Graham Number. Use it as a starting point, not a final decision tool.
Frequently Asked Questions
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