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The Graham Number

Derived from a Motley Fool supported article by Kapitall http://www.fool.com/investing/general/2011/02/16/the-godfather-of-value-investings-secret-formula-6.aspx?source=iaasitlnk0000003

The Graham Number:

Fair Value of a Stock = Square Root of [(22.5) x (Earnings Per Share) x (Book Value Per Share)]

The math of the Graham number is relatively straightforward. Graham believed that the price-to-earnings (P/EPS) ratio should be no more than 15. He also believed that the price-to-book value (P/BVPS) ratio should be no more than 1.5.

From that, Graham proposed that -- as a rule of thumb -- the product of the two should not be more than 22.5. In other words, (P/EPS of 15) x (P/BVPS of 1.5) = 22.5.

Put another way:

(Price/EPS) x (Price/BVPS) = 22.5

Price(sqr)/(EPS x BVPS) = 22.5

Price(sqr) = 22.5 x EPS x BVPS

Once you take the square root of both sides, you get the equation for the Graham Number.

Fair Value Price = Square Root of (22.5 x EPS x BVPS)

The Graham Number can be helpful in determining the relative value of the stock you're looking at. Bear in mind, it's not a substitute for doing own your homework -- but it can be a good starting point for your research.

Another Foolish Article: http://www.fool.com/investing/general/2012/02/27/the-graham-number-and-intelligent-investing.aspx

With some more elaboration from here: Graham Number and Warren Buffett Portfolio http://community.nasdaq.com/news/2012-06/graham-number-and-warren-buffett-portfolio.aspx?storyid=152175&source=TheMotleyFool

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