The Graham Number: Benjamin Graham's Formula for Finding Undervalued Stocks

The Graham Number is a valuation formula developed by Benjamin Graham, widely considered the father of value investing and the mentor of Warren Buffett. It provides a quick estimate of the maximum price a defensive investor should pay for a stock based on its earnings and book value.

The formula multiplies earnings per share by book value per share, multiplies that result by 22.5, and then takes the square root. The constant 22.5 comes from Graham's belief that a stock should not trade above 15 times earnings and 1.5 times book value. Since 15 multiplied by 1.5 equals 22.5, the formula elegantly combines both criteria into a single number.

How to Use the Graham Number

If a stock's current price is below its Graham Number, it may be undervalued according to Graham's conservative criteria. If it trades significantly above, it fails Graham's test for defensive investors.

For example, if a company has earnings per share of 10 dollars and book value per share of 50 dollars, the Graham Number would be the square root of 22.5 multiplied by 10 multiplied by 50, which equals approximately 106 dollars. If the stock trades at 80 dollars, it passes Graham's filter. If it trades at 150 dollars, it does not.

Strengths of the Graham Number

The formula is simple, quick, and conservative. It requires only two data points that are readily available in any financial statement. It enforces discipline by screening out stocks that are expensive on both an earnings and asset basis. For defensive investors who prioritize capital preservation over growth, it remains a useful first filter.

Limitations

The Graham Number was designed in an era when most companies were asset-heavy manufacturers. It struggles with modern technology and service companies that have minimal book value but enormous earnings power. A company like Apple has a relatively low book value compared to its market capitalization because its value lies in intellectual property, brand, and ecosystem rather than physical assets.

The formula also ignores growth entirely. A company growing earnings at 30 percent per year is treated the same as one with flat earnings. This makes the Graham Number too conservative for growth stocks and most useful for mature, asset-rich businesses in sectors like financials, industrials, and utilities.

Graham Number vs Modern Valuation

Modern valuation approaches like DCF analysis and relative valuation address many of the Graham Number's limitations by incorporating growth projections, sector comparisons, and multiple financial metrics. Fair Price Index combines these modern methods into a single fair price for each stock, providing a more comprehensive view than any single formula can offer.

However, Graham's core principle remains as relevant as ever: always know what you are paying relative to what you are getting. Whether you use the Graham Number, DCF, or a blended model like Fair Price Index, the goal is the same. Never pay more than a business is worth.

Explore fair values for 37,000 plus stocks at fairpriceindex.com.