Graham Number

The Graham Number is a valuation formula developed by Benjamin Graham, the father of value investing. It provides a maximum price a defensive investor should pay for a stock based on its earnings per share and book value per share.

The formula is the square root of 22.5 multiplied by EPS multiplied by book value per share. 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 times 1.5 equals 22.5, the formula elegantly combines both criteria.

Using 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.

The Graham Number works best for mature, asset-heavy businesses in sectors like financials, industrials, and utilities. It struggles with modern technology companies that have minimal book value but enormous earnings power.

Despite its limitations, Graham's core principle remains relevant: always know what you are paying relative to what you are getting. Modern valuation methods like DCF address some limitations, but the discipline of valuation remains essential.