What is the Graham number and how do you use it to find undervalued stocks
The Graham number is a simplified value metric inspired by Benjamin Graham's defensive investing criteria. It combines earnings and book value into a single number that can serve as a quick filter, not as a complete valuation.
- Find the company's earnings per share (EPS) on a trailing 12-month basis.
- Find the company's book value per share (BVPS) from the latest balance sheet.
- Multiply EPS by BVPS.
- Multiply the result by 22.5, a constant based on Graham's limits for price-to-earnings and price-to-book ratios.
- Take the square root of that result. The final number is the Graham number.
The Graham number formula
The Graham number formula is:
Graham number = square root of (22.5 × EPS × BVPS)
The constant 22.5 comes from Graham's defensive investing rule that a stock should not sell for more than 15 times earnings and more than 1.5 times book value. Multiplying those two limits gives 22.5.
For example, take a hypothetical company with EPS of $4 and BVPS of $20. The formula becomes:
square root of (22.5 × 4 × 20) = square root of 1,800 = about 42.4
That result is a rough ceiling. If the stock trades below that number, it passes one traditional value screen. If it trades above, it fails that simple test.
How the Graham number works
Graham believed that a conservative investor should not pay too much for a stock in relation to current earnings and the net assets behind the stock. The Graham number captures both concerns in one figure. A stock below the Graham number offers a margin of safety, at least in the same spirit Graham described.
The metric works best for mature, asset-heavy companies with stable earnings and meaningful book value. Banks, manufacturers, energy producers and similar businesses often have the kind of tangible assets that make this screen meaningful.
How to use the Graham number as a value screener
The Graham number is most useful as an early-stage filter. Here is a practical way to approach it:
- Calculate the Graham number for the stocks on your watchlist.
- Compare the current share price with the Graham number. A price below the number suggests a possible bargain.
- Look for a meaningful gap, not just a small difference. Graham favored buying with a clear margin of safety.
- Put promising candidates through deeper analysis, including the balance sheet, cash flow statement, debt levels and competitive position.
A common mistake is to treat any stock below the Graham number as an automatic buy. The number is a starting point. It does not tell you why the stock is cheap. Sometimes the market is right, and the company is cheap because its fundamentals are deteriorating.
Limitations in modern markets
The Graham number has several limits that matter more today than in Graham's time:
- Negative earnings or book value. If EPS or BVPS is negative, the formula produces no useful result.
- Share buybacks. Companies that repurchase shares can raise book value per share without adding real economic value, which pushes the Graham number higher.
- Intangible assets. The formula ignores the value of brands, patents, software, data and customer relationships. Many modern companies create enormous value from intangibles that never appear on a traditional balance sheet.
- Growth assumptions. A high-growth company with modest current earnings can look permanently overvalued on this metric, even when its future prospects are strong.
- **Debt. The formula does not separate a strong balance sheet from a weak one. Two companies can have the same book value while carrying very different levels of debt.
- Sector differences. The metric was designed for common stocks with tangible assets, not for technology platforms, biotech research and other asset-light models.
Graham number vs other valuation tools
| Method | Core question | Best used for |
|---|---|---|
| Graham number | Is the price low relative to earnings and book value? | Quick screen of mature, asset-heavy businesses |
| Price-to-earnings ratio | How much am I paying for current earnings? | Comparing similar companies in the same industry |
| Discounted cash flow | What are future cash flows worth today? | Businesses with predictable, visible cash flows |
The Graham number does not replace these tools. It narrows the field so you can spend more time on serious analysis.
The bottom line
The Graham number is a simple, conservative way to spot possible value opportunities. It works best as a filter, not as a final verdict. Use it alongside traditional financial-statement analysis and always check the company's debt, cash flow and future prospects before making any judgment.
This guide is for education and analysis, not personalized financial advice.
AlphaTeak scores any stock across eight pillars, estimates fair value, and keeps an honest, public track record. Analysis and education, not advice.
Get AlphaTeak