Graham Number: Definition, Formula, Example, and Limitations

What it is

The Graham number (or Benjamin Graham’s number) is a simple valuation rule that estimates the maximum price a defensive value investor should pay for a stock. It combines a company’s earnings and book value to identify potentially undervalued shares.

Key takeaways

• Created by Benjamin Graham, a founder of value investing.
• Uses earnings per share (EPS) and book value per share (BVPS).
• Built on Graham’s guideline that P/E ≤ 15 and P/B ≤ 1.5 (15 × 1.5 = 22.5).
• Intended as a rough screen, not a standalone buy/sell signal.

Formula and how it’s derived

Graham set an upper limit for a reasonable price by multiplying his recommended P/E and P/B ratios: 15 × 1.5 = 22.5. The Graham number is the square root of 22.5 times EPS times BVPS:

Graham number = √(22.5 × EPS × BVPS)

Where:
* EPS = net income attributable to common shareholders divided by outstanding common shares. Graham recommended using an average of the past three years’ EPS to reduce year-to-year distortion.
* BVPS = (equity available to common shareholders) ÷ (outstanding common shares). BVPS represents the book value per share.

Example

If a company’s EPS = $1.50 and BVPS = $10.00:

Graham number = √(22.5 × 1.50 × 10) = √(337.5) ≈ $18.37

According to the Graham number, $18.37 is the upper limit a defensive investor should pay for one share. A market price below that could be considered more attractive; a price above it would be less attractive by this rule.

Limitations

• Omits qualitative and many quantitative fundamentals (management quality, competitive advantage, industry dynamics, growth prospects).
• Uses book value, which can be less meaningful for asset-light or intellectual-property-heavy businesses.
• Relies on historical earnings, which may not reflect future performance or one-time items.
• Not suitable for high-growth companies where higher P/E or P/B ratios may be justified.
• Best used as an initial screen that should be followed by deeper fundamental analysis.

Explain Like I’m Five

The Graham number is a quick way to check if a stock looks cheap: it uses how much profit the company makes per share and how much its assets are worth per share to give a maximum “safe” price. If the market price is below that number, the stock might be a bargain — but you should check other things too.

Common questions

Q: Is a lower price than the Graham number a sure buy?
A: No. It’s a signal to investigate further, not a guarantee. Check business quality, competitive position, and future earnings prospects.

Q: Should I use one year of EPS or an average?
A: Graham recommended averaging EPS over several years (commonly three) to smooth out variability and manipulation.

Q: Does the Graham number work for all industries?
A: It’s more appropriate for established, asset-based businesses. For high-growth or asset-light firms, the measure can be misleading.

Who was Benjamin Graham?

Benjamin Graham is widely regarded as the father of value investing. He emphasized careful analysis of financial statements to find undervalued securities and authored foundational texts such as The Intelligent Investor.

Bottom line

The Graham number is a straightforward, conservative valuation metric that combines earnings and book value to suggest a maximum safe price for a stock. It’s useful as a screening tool but should be complemented with comprehensive fundamental analysis before making investment decisions.