The Graham Number

Being a huge fan of the father of value investing, Benjamin Graham, I am quickly delighted to learn a new valuation method to determine the fair value. I was browsing one of the investment groups on Facebook when someone posted their valuation. Every time someone posts their valuations, I get curious and I would like to know how they make their computations. 

Now having finished the book Security Analysis, Graham's first book of 900 pages, I am already quite at ease with the basic computations that Graham makes, such as Price to Earnings ratio, Book Value, Earnings per Share and Margin of Safety.

Going back to the post I saw, I quickly recognized these variables and simple calculations that I use so much and hold so dearly. I immediately understood how they are computed, except for the target price or fair value im his computation. It wasn't in Ben Graham's first book so it must be a newer concept that he'd made. I asked the guy who posted, who, in his profile was a stock broker for one of the online stock brokerages, told me that it was the Graham number. I did not recognize it right away, but I looked it up. 

The formula was simple enough and it consolidated all of my favorite variables in one simple formula!

I was excited to try and understand it.

Here it is:

(Image taken from Wikipedia)

For a more detailed description visit here: 

https://en.m.wikipedia.org/wiki/Graham_number

True enough, the formula was found in Graham's later book, "The Intelligent Investor".

Let's make a sample computation using my favorite stock CDC, Cityland Development Corporation, the builder of condominiums around the Metro Manila area.

In my case, (these numbers are highly preferential), I buy if the stock is below a P/E ratio of 10, which means it must return at least 10% per year, and if the stock is selling below its book value (net asset value). Thus, the multiplier for my Graham Number will be 10x1=10, replacing Graham's 22.5.

Thus my formula has become even more conservative. 

The formula should look like this:

     __________________________________________________

   /

\/     10   X   (earnings per share)   X   (book value per share)

Now let's try it with my favorite stock. First with Graham's original multiplier of 22.5

Looking at the financial results for 2015, Cityland Development Corporation (taken from PSE.edge website)

Book Value per Share: 1.47

Earnings per Share: 0.21

With Graham's original multiplier, I got a fair value of: P 2.64 as the maximum price I can pay for the stock.

With my more conservative multiplier, I got a fair value of: P 1.76

With CDC shares selling at around P 1.00 that would constitute a very very good buy. ;)