Valuing a stock with the Graham formula

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There are several ways to assess a stock, besides the stock table. One of them is the Graham formula, created by Benjamin Graham.

graham is the father of “value investing”

His book, the Intelligent Investor is considered a classic in the financial industry. Despite being published in 1949, its principles still hold true today. Graham hired Warren Buffet so we can safely say the guy knew what he was talking about!

what is the graham formula?

The formula was created to assess how rationally priced a stock is. In today’s market, when it is becoming more and more difficult to find fairly valued or undervalued stock, the formula is very relevant.

For you math-diggers out there, the formula was initially as follow:

V*=EPS\times (8.5+2g)

V as the intrinsic value, EPS as the company’s Earning per Share over the last 12 months, 8.5 being the ratio for a company not making any profit, g being the company’s estimated growth for the next 5 years.

Later, it was revised to: V*={\cfrac {EPS\times (8.5+2g)\times 4.4}{Y}}

Y being the current yield on 20 year AAA corporate bonds. Graham thought taking interest rates into consideration would give a more accurate intrinsic value (V).

how do I use the formula? 

Don’t worry, there are plenty of calculators that will give you the intrinsic value of any stock. There is a good one here.

Once you have the intrinsic value divide it by the stock current price. If the result is below 1, it means the stock is overvalued. If it is above 1, the stock is either fairly valued or undervalued.

final word

The graham formula is an helpful way to assess a stock. That being said, it should not be the only one way used. It is important to do research on the company and to read – and understand-its financial statements.

 

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