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GRAHAM'S NUMBER
By Alex Williams
5-4-2007
Benjamin Graham isn’t considered one of the greatest investors of
all time for no reason…
To get an idea of just how good he was, consider this: After the
1929 stock market crash, and during the Great Depression of the
1930s – perhaps the worst bear market ever – Graham averaged
returns of 17% a year…
And during the last great bear market from 1971-1982, the average
annual return on stocks meeting Graham’s “value” criteria was
33.7% a year, according to one study.
So how did one investor not only survive, but prosper
handsomely during some of the toughest markets in the American
economy?
For Graham, it was one simple number, now known as Graham’s
number. And yet today, this one metric is still one of the best ways
to determine value.
The fact is, buying companies at deep discounts has made millions
for investors who know how to find them before the market
realizes what a good deal they are.
Only problem is that really good value analysts are far and few
between. Warren Buffett, Legg Mason’s Bill Miller, and Graham
are perhaps three of the best.
But we’re going to let you in on a little secret – the famous
“Graham’s Number.” He used it to uncover some of his most
profitable investments. Today, you’ll see how to use it to uncover
some of your own. It takes about three minutes to use…
Calculating “Graham’s Number”
Ben Graham, the “father of value investing,” wrote the bible on
securities analysis in the 1930s – and it’s the main book on the
subject today. He was also Warren Buffett’s mentor, having taught
him in college at Columbia University.
So what is Ben Graham’s “Secret Number?” Well, it easily boils
down to this: Buy cash at a discount.
Actually, it’s cash and things that can be easily turned into cash.
Graham’s idea is that if you can pay as little as two-thirds of “cash”
for a stock, you’ve really got nothing to lose.
Here’s how to get “Graham’s Number” for any company: Current
Assets minus Total Debts.
Current assets are defined as anything that can be turned into cash
within a year. Total debt is self-explanatory. So another way to
describe “Graham’s Number” is a company’s Net Current Assets.
Yet another way to think of it is basically the cash that is left if you
were to pay off all debts. And, if you find a company that’s going
for two-thirds – or 66% of – the value of its cash, that’s a “value”
play.
As you might expect, it’s difficult to find stocks this cheap. To give
you an idea of how stringent the criteria are: Out of the thousands
of stocks out there, only a tiny handful qualify as good value
investments under Graham’s criteria.
Let’s use a hypothetical example, so you’ll see how easy it is to
locate a true “value” investment by determining its “Graham’s
Number” on your own…
Finding A Company’s Net Current Assets
First we need to get the Current Assets and the Total Liabilities of
Company XYZ. You can do this in Yahoo! Finance (www.yahoo.
com, click on “Finance”). Enter the stock symbol of the company
you’re looking for and click on “Balance Sheet,” on the bottom, left-
hand-side of the page.
Let’s say the balance sheet for Company XYZ says the following:
$3.6 billion Current Assets, and $2.1 billion Total Debt. Therefore,
“Graham’s Number” (or net current assets) is $1.5 billion.
Now we need to consider the market value of Company XYZ (also
called the “market cap” and calculated as number of shares times
current market price). Is XYZ an extraordinary bargain, selling at
less than two-thirds of its net current assets?
Let’s say Company XYZ’s market cap is $1.3 billion at the moment.
So you can buy the stock for less than its net current assets – you’re
buying at a discount to cash, in a sense. A bargain.
However, in order to buy at two-thirds of Graham’s number (1.5
billion, in this case), you’d want XYZ’s market value to be at $1.0
billion or less (66% of 1.5 billion). Cutting to the chase, the current
price for XYZ ($6.50, which equates to $1.3 billion in market cap)
isn’t at the 66% level we’d need to make this a “Graham’s
Number” investment. The price will have to come down to $5 per
share for that.
You can do this homework yourself to find stocks that meet this
criteria. It will likely take a little wrestling of stock screeners and
spreadsheets, or checking out the Value Line. But the hard work
can have a significant payoff.
By Alex Williams
5-4-2007
Benjamin Graham isn’t considered one of the greatest investors of
all time for no reason…
To get an idea of just how good he was, consider this: After the
1929 stock market crash, and during the Great Depression of the
1930s – perhaps the worst bear market ever – Graham averaged
returns of 17% a year…
And during the last great bear market from 1971-1982, the average
annual return on stocks meeting Graham’s “value” criteria was
33.7% a year, according to one study.
So how did one investor not only survive, but prosper
handsomely during some of the toughest markets in the American
economy?
For Graham, it was one simple number, now known as Graham’s
number. And yet today, this one metric is still one of the best ways
to determine value.
The fact is, buying companies at deep discounts has made millions
for investors who know how to find them before the market
realizes what a good deal they are.
Only problem is that really good value analysts are far and few
between. Warren Buffett, Legg Mason’s Bill Miller, and Graham
are perhaps three of the best.
But we’re going to let you in on a little secret – the famous
“Graham’s Number.” He used it to uncover some of his most
profitable investments. Today, you’ll see how to use it to uncover
some of your own. It takes about three minutes to use…
Calculating “Graham’s Number”
Ben Graham, the “father of value investing,” wrote the bible on
securities analysis in the 1930s – and it’s the main book on the
subject today. He was also Warren Buffett’s mentor, having taught
him in college at Columbia University.
So what is Ben Graham’s “Secret Number?” Well, it easily boils
down to this: Buy cash at a discount.
Actually, it’s cash and things that can be easily turned into cash.
Graham’s idea is that if you can pay as little as two-thirds of “cash”
for a stock, you’ve really got nothing to lose.
Here’s how to get “Graham’s Number” for any company: Current
Assets minus Total Debts.
Current assets are defined as anything that can be turned into cash
within a year. Total debt is self-explanatory. So another way to
describe “Graham’s Number” is a company’s Net Current Assets.
Yet another way to think of it is basically the cash that is left if you
were to pay off all debts. And, if you find a company that’s going
for two-thirds – or 66% of – the value of its cash, that’s a “value”
play.
As you might expect, it’s difficult to find stocks this cheap. To give
you an idea of how stringent the criteria are: Out of the thousands
of stocks out there, only a tiny handful qualify as good value
investments under Graham’s criteria.
Let’s use a hypothetical example, so you’ll see how easy it is to
locate a true “value” investment by determining its “Graham’s
Number” on your own…
Finding A Company’s Net Current Assets
First we need to get the Current Assets and the Total Liabilities of
Company XYZ. You can do this in Yahoo! Finance (www.yahoo.
com, click on “Finance”). Enter the stock symbol of the company
you’re looking for and click on “Balance Sheet,” on the bottom, left-
hand-side of the page.
Let’s say the balance sheet for Company XYZ says the following:
$3.6 billion Current Assets, and $2.1 billion Total Debt. Therefore,
“Graham’s Number” (or net current assets) is $1.5 billion.
Now we need to consider the market value of Company XYZ (also
called the “market cap” and calculated as number of shares times
current market price). Is XYZ an extraordinary bargain, selling at
less than two-thirds of its net current assets?
Let’s say Company XYZ’s market cap is $1.3 billion at the moment.
So you can buy the stock for less than its net current assets – you’re
buying at a discount to cash, in a sense. A bargain.
However, in order to buy at two-thirds of Graham’s number (1.5
billion, in this case), you’d want XYZ’s market value to be at $1.0
billion or less (66% of 1.5 billion). Cutting to the chase, the current
price for XYZ ($6.50, which equates to $1.3 billion in market cap)
isn’t at the 66% level we’d need to make this a “Graham’s
Number” investment. The price will have to come down to $5 per
share for that.
You can do this homework yourself to find stocks that meet this
criteria. It will likely take a little wrestling of stock screeners and
spreadsheets, or checking out the Value Line. But the hard work
can have a significant payoff.
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