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Praveen Chawla
Articles (38) 

Revisiting the Graham Number

A review of the classic value investing ratio that comes into its own when a recession is near and fear is in the air

May 14, 2020 | About:

The Graham number is named after the father of value investing Benjamin Graham, who was a mentor of Warren Buffett (Trades, Portfolio). The figure takes into account earnings per share and book value per share to measure a stock's maximum fair market value. In other words, it is the upper end of the price range that a defensive investor should pay for a stock.

Theoretically, any stock trading below its Graham number is considered undervalued, but from a practical point of view, it works best for large-cap stocks that depend on the balance sheet to generate earnings: companys like banks, car manufacturers, etc. It does not work well for companies with light balance sheets and that depend on intellectual property (like patents, brand names or network effect). Technology and pharma are examples of this.

The formula is as follows: Graham number = Square Root of (22.5) x (TTM EPS) x (MRQ Book Value per Share).

The 22.5 is included in the formula as a rule of thumb to account for Graham's thinking that the price-earnings ratio should not be over 15 and the priceook ratio should not be over 1.5 for an undervalued stock. So the number is generated as (P/E of 15) x (P/B of 1.5) = 22.5. This number is thus an amalgamation of the two ratios.

The Graham number is a very conservative way to screen for stocks, and GuruFocus makes this very easy as it is provided for each stock on the Summary page and the price to Graham number ratio is also available on the All-in-One Screener.

I am finding that many Tier 1 bank stocks are selling at attractive prices compared to their Graham numbers. JPMorgan Chase & Co. (NYSE:JPM) is arguably one of the best-run banks in the world and theWarren Buffett (Trades, Portfolio) pick is now selling for below its Graham number. Historically, the buying zone can be spotted when the stock is trading below this level.72173b43cf0b529aa418a9e4039b31e2.png

The chart below is similar to the one above for JPMorgan, but also adds a price-earnings line at 15 and the price-book ratio at 1.5, which denotes the upper limit of what Graham thought a conservative investor ought to pay for a stock.


Similar to JPM, Wells Fargo & Co. (WFC) is another one Buffett's banks that is now trading below its Graham number. It has not done so in the past two recessions.


Iwroteabout Wells Fargo recently and think it is preparing well for the recession ahead.

Cullen/Frost (NYSE:CFR) is another bank I really like which I am considering buying because of its low leverage. It is conservatively run and well managed, and even though it is in Texas it is not very much exposed to the oil industry. Dips below the Graham number line have historically been a profitable time to buy.


The Graham number line can also be used to generate buy signals for cyclical stocks. Below is a chart for Nucor (NYSE:NUE), the largest steelmaker in the U.S. It is a highly cyclical stock that is now trading below the Graham number. It was only during the previous recessions the stock dipped briefly below the line, which triggered a buy signal. Interestingly, while the Graham number line stayed quite low for Nucor during the recovery, the stock always stayed well above.

But keep in mind that a discount to the Graham number is not always worth getting excited about. Share prices can stay below theGraham line for quite some time while still getting cheaper. I find it most useful to identify fundamentally strong companies during periods of economic turbulence when many investors are running for the exit and value investing is out of favor.

Though the calculation is easy and the concept simple, it does not consider many fundamental characteristics which are also important in identifying promising undervalued stocks, like return on invested capital, moat, business model or management quality. It is just a starting point for further research.

Disclosure: The author is long JPMorgan.

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