Graham’s Number
If you follow me on Twitter (@shervin) you’ve heard me talk about what I look for when making investments. This week I am thinking about Benjamin Graham, the man who wrote a book titled “The Intelligent Investor,” which was first published in 1949. Warren Buffett reportedly described reading that book as one of the luckiest moments in his life.
In the course of his investing adventures, Graham developed a formula, a.k.a. Graham’s number, that measures a stock’s fundamental value by taking into account the company’s earnings per share (EPS) and book value per share (BVPS).
The formula to find the Graham Number states that the price of a stock should be less than or equal to the square root of 22.5 times the earnings per share (EPS) multiplied by the book value per share (BVPS).
A little background here: After graduating from Columbia University in 1914, Benjamin Graham went to work on Wall Street. During his 15-year career, he was able to cultivate a sizable personal nest egg. Unfortunately, Graham lost a lot of his money in the stock market crash of 1929 and the subsequent Great Depression. You can see how those experiences taught him lessons about minimizing risk.
If you visit YouTube, you’ll find a lot of channels that seem to complicate the meaning of Graham’s number. If you are a new investor, don’t let that discourage you or keep you from the takeaway advice Graham has written about.
In a nutshell, Benjamin Graham urges the twin principles of valuation and patience for anyone that wants to succeed as an investor. In order to determine a company’s true worth, you must be prepared to do the research. Then, once you’ve bought shares of a company, you must be prepared to wait.
I also think it’s interesting that Graham was instrumental in drafting elements of the Securities Act of 1933, legislation requiring companies to provide financial statements certified by independent accountants.
Personally, I look for startups led by passionate founders that bring a paradigm shift to the market. Any characteristic that is hard to replicate is what is known as a company’s economic moat, or competitive advantage.
