# Graham Number: Definition, Formula, Example, and Limitations

![Graham Number: Measures a stock's fundamental value by taking into account the company's earnings per share (EPS) and book value per share (BVPS).](https://www.investopedia.com/thmb/0j3TzSjy6iXGTtv-dtzltLADqEE=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/graham-number.asp-final-ce508e6a898b4d2394792c6ac3708705.png)

*— Investopedia / Theresa Chiechi*

> **Definition**
>
> The Graham number is a tool that can reveal stocks considered to be undervalued.

## What Is the Graham Number?

The Graham number (or Benjamin Graham's number) is a valuation metric that determines the maximum price an investor should pay for a stock. So, a defensive investor would pay no more than the Graham number.

According to the theory, any stock with a price below the Graham number is considered undervalued and thus potentially worth investing in.

The Graham number is derived from the company's [earnings per share (EPS)](https://www.investopedia.com/terms/e/eps.asp) and [book value per share (BVPS)](https://www.investopedia.com/terms/b/bvps.asp).

### Key Takeaways

*   The Graham number was created by legendary value investor Benjamin Graham.
*   The number is arrived at using a company's earnings and book value, both on a per-share basis.
*   Graham recommended that the P/E ratio multiplied by the price-to-book value ratio be no more than 22.5.
*   He also intended that the number be used with other stock selection criteria, not on its own.

## Understanding the Graham Number: Formula and Calculation

The Graham number is named after the so-called father of [value investing](https://www.investopedia.com/terms/v/valueinvesting.asp), [Benjamin Graham](https://www.investopedia.com/terms/b/bengraham.asp). It is used as a general test for intrinsic value when trying to identify stocks that are currently selling for an attractive price.

A figure of 22.5 is included in the calculation of the Graham number to account for Graham's belief that the current price should not be more than 15 times average earnings for the previous three years. Nor should the current price be more than 1.5 times the latest reported book value.

A [price-to-earnings (P/E)](https://www.investopedia.com/terms/p/price-earningsratio.asp) ratio of 15 multiplied by the price-to-book ratio of 1.5 equals 22.5.

Graham noted explicitly, "As a rule of thumb, we suggest that the product of the multiplier times the ratio of price-to-book value should not exceed 22.5."

The Graham number can be calculated as:

$\sqrt{22.5\ \times\ \text{(earnings per share)}\ \times\ \text{(book value per share)}}$

Where:

*   Earnings per share (EPS) is calculated as a company's net profit divided by the number of [outstanding shares](https://www.investopedia.com/terms/b/bvps.asp) of its common stock. Graham recommended that the average of the past three years' EPS be used because a single year's EPS could be easily manipulated.
*   Book value per share (BVPS) is the ratio of equity available to common shareholders divided by the number of outstanding shares. This figure represents the minimum value of a company's equity and measures the [book value](https://www.investopedia.com/terms/b/bookvalue.asp) of a firm on a per-share basis.

> **Fast Fact**
>
> While Graham felt that the current price should not be more than 1 ½ times the book value last reported, a P/E below 15 could justify a correspondingly higher price-to-book value ratio. 

## Example of the Graham Number

If the earnings per share for a single share of company ABC is $1.50 and the book value per share is $10, the Graham number would be 18.37. ((22.5\*1.5\*10)\= 18.37).

So, $18.37 is the maximum price a value investor should pay for a share of ABC, according to Graham. If ABC is priced at $16, it is getting more attractive; if priced at $19, it should be avoided.

## Limitations of the Graham Number

The calculation for the Graham number does leave out many fundamental characteristics, which are considered to comprise a good investment, such as [management quality](https://www.investopedia.com/terms/q/quality-management.asp), [major shareholders](https://www.investopedia.com/terms/p/principal-shareholder.asp), industry characteristics, and the competitive landscape.

For stocks, [fundamental analysis](https://www.investopedia.com/terms/f/fundamentalanalysis.asp) is a method of determining essential value that focuses on key metrics and economic indicators, such as revenues, earnings, where an industry is in its cycle, [return on equity (ROE)](https://www.investopedia.com/terms/r/returnonequity.asp), and profit margins.

Fundamental analysis relies on a company’s financial statements. One of the most famous and successful fundamental analysts, [Warren Buffett](https://www.investopedia.com/terms/t/the_greatest_generation.asp)—"the Oracle of Omaha"—is famous for successfully employing fundamental analysis.

Warren Buffett was both a student and employee of Benjamin Graham. The fundamental method of security analysis is considered to be the opposite of [technical analysis](https://www.investopedia.com/terms/t/technicalanalysis.asp).

## Explain Like I'm Five

Graham's number is a simple measure of a stock's real value, based on a company's earnings and the value of its assets and liabilities. If the market price of a stock is lower than the Graham number, the price is considered likely to increase.

Graham's number is popular for value investors because it provides a simple, universal metric that can be applied to companies in any industry.

However, it should be looked at along with other stock selection criteria rather than relied on alone.

## What Is a Good Graham's Number?

Graham's number will always present a maximum stock price given a company's EPS and BVPS. As a result, any stock price below that figure could potentially signal a good buy for a value investor.

## How Does the Graham Number Work in Value Investing?

The Graham number takes a company's per-share metrics and normalizes it based on a recommended upward limit for value investors of 15x P/E and 1.5x P/B.

## Who Was Benjamin Graham?

Benjamin Graham is one of the founding fathers of value investing and a financial guru to famous value investors, such as Warren Buffett. Graham's philosophy was to closely examine a company's financial statements to identify undervalued opportunities. His book "The Interpretation of Financial Statements" is widely regarded as foundational for value investing.

## The Bottom Line

The Graham number measures a stock's fundamental value by taking into account the company's EPS and BVPS.

It represents the highest price that a defensive investor should pay for a stock, and it suggests that any stock price below the Graham number is undervalued and thus worth paying.

_**Correction—March 21, 2024**:_ This article has been corrected to state Graham's belief that the price-to-book ratio should not be over 1.5x.

> **Article Sources**
>
> 1.  Benjamin Graham. "[The Intelligent Investor, Revised Edition](https://irp-cdn.multiscreensite.com/cb9165b2/files/uploaded/The%20Intelligent%20Investor%20-%20BENJAMIN%20GRAHAM.pdf)," Pages 348-349. Harper Business, 2006.
>     
> 2.  Benjamin Graham. "[The Intelligent Investor, Revised Edition](https://irp-cdn.multiscreensite.com/cb9165b2/files/uploaded/The%20Intelligent%20Investor%20-%20BENJAMIN%20GRAHAM.pdf)," Page 310. Harper Business, 2006 (Revised Edition).
>     
> 3.  Benjamin Graham. "[The Intelligent Investor, Revised Edition](https://irp-cdn.multiscreensite.com/cb9165b2/files/uploaded/The%20Intelligent%20Investor%20-%20BENJAMIN%20GRAHAM.pdf)," Page 349. Harper Business, 2006.