Graham Number Formula — Fair Value Ceiling
Learning Objectives
After reading this chapter, you will be able to:
- Explain how the Graham Number combines EPS and BVPS to produce a conservative fair value — most useful for banking, financial, and asset-rich companies; supplementary for IT and brand businesses; successful investors use it as a screen, not a final decision
- Apply Graham Number metrics and formulas using consolidated NSE/BSE annual report data
- Identify red flags when interpreting Graham Number: buying based on Graham Number alone
- Connect Graham Number analysis to peer comparison and buy/hold/avoid decisions
Introduction
The most important question in value investing:
"What is this share truly worth?"
A great company at an expensive price = poor return. A good company below fair price = higher probability of success. Benjamin Graham addressed this with the Graham Number formula — a conservative fair value estimate.
Core Concepts
Financial Terms
| Term | Meaning |
|---|---|
| Graham Number | Conservative fair value based on EPS and BVPS |
| EPS | Earnings Per Share — profit per share |
| BVPS | Book Value Per Share — book value per share |
| P/E | Price-to-Earnings Ratio |
| P/B | Price-to-Book Ratio |
| Margin of Safety | Discount calculated from the Graham Number |
Investment Decision
Golden Rule: The Graham Number is not a buy signal — it is a signal to start research.
Novice investor: What is the share price? Experienced investor: What is the P/E? Value investor: What is the Graham Number? Professional analyst: "Does business quality justify this valuation?"
"A company's value comes from its earnings and assets. The market's opinion is temporary." — Benjamin Graham
In simple terms:
The Graham Number is a conservative fair value estimate combining a company's earnings (EPS) and book value (BVPS).
Purpose: "Avoid excessively optimistic valuation."
Graham's view — business value comes mainly from two things:
- Earnings Power (EPS)
- Asset Strength (Book Value)
EPS = ₹20, BVPS = ₹100
| Share Price | Interpretation |
|---|---|
| ₹150 | Possibly undervalued |
| ₹350 | Expensive by Graham's measure |
Graham Number = ₹200, Current Price = ₹140
The investor can now proceed with further research.
❌ Not a target price ❌ Not a future price ❌ Not a guaranteed return
It is only a conservative valuation estimate.
| Most Useful | Less Useful |
|---|---|
| Banking Stocks | IT Companies |
| Financial Stocks | SaaS Companies |
| Manufacturing | Platform Businesses |
| Asset Rich Companies | Brand Heavy Companies |
Examples (useful): PFC, REC, Bank of Baroda, Canara Bank Examples (less useful): TCS, Infosys, Persistent Systems — brand, technology, and customer relationships are not fully reflected in book value
Formula & Explanation
Where Does 22.5 Come From?
Graham's conservative assumption:
Graham was saying: "If a company trades above P/E 15 and P/B 1.5, exercise caution."
Visual Guide
Worked Example — Indian Market
Formula Application
EPS ₹50, BVPS ₹200 → √(22.5 × 50 × 200) ≈ ₹474. Price ₹400 → below Graham; confirm earnings not one-time.
Real World Example
Suppose you want to buy a house. The broker quotes ₹1.5 crore. You calculate independently — land, construction, nearby area prices — and find: ₹1 crore.
"The broker's price and the true price can differ."
The same happens in the stock market. Market price is not always correct. That is why Graham created a conservative fair value formula.
Case Study
PFC
Price = ₹450, Graham Number = ₹700 → possible value opportunity. But I would also review NPA, loan book quality, dividend, and government risk.
Maithan Alloys
I would compare the Graham Number after reviewing the commodity cycle, cash position, and debt.
TCS / Asian Paints / Nestlé India
Many great companies traded above their Graham Number for years — yet delivered excellent returns. The Graham Number is not the final truth; it is only a starting point.
Disclaimer: Historical examples are illustrative; past performance does not guarantee future results.
CFA Exam Tip
I use the Graham Number as a screen tool:
- Price < Graham Number → further research
- Price > Graham Number → deeper valuation analysis (the share may not be bad, just expensive)
I also review: ROE, ROCE, Debt-to-Equity, Free Cash Flow, Altman Z-Score, Promoter Holding.
NSE Screening Filter (initial)
Common Mistakes
- Buying based on Graham Number alone
- Ignoring debt
- Buying a negative cash flow company
- Ignoring commodity cycles
- Ignoring business quality
- Business quality check missing alongside Graham Number
- Low price with negative cash flow
- High debt + low Graham Number premium
- Using peak commodity earnings for EPS
- Relying on Graham Number alone for IT/brand businesses
Key Takeaways
The Graham Number combines EPS and BVPS to produce a conservative fair value. It is most useful for banking, financial, and asset-rich companies; supplementary for IT and brand businesses. Successful investors use it as a screen tool, not a final decision.
Practice Questions
Chapter: Graham Number | Part 04 | Try before reading answers.
Q1 (Conceptual): What is the core message of this chapter in one sentence?
Q2 (Calculate): Calculate: √(45{,}000) ≈ ₹212?
Q3 (Application): How do Graham Number and BVPS interact in Graham Number decisions?
Q4 (Red Flag): Red flag: buying based on Graham Number alone — why avoid relying on Graham Number alone?
Q5 (CFA Style): CFA-style trap when interpreting Graham Number?
Q6 (Decision): Invest / wait / avoid — 3 bullets using Graham Number framework on one stock.
Q7 (Lab): Complete one Graham Number exercise in Part 04 Practice Lab.
Answer Key
Q1 (Conceptual)
The Graham Number is a conservative fair-value screen from EPS and BVPS — start research when price is below it, never buy on the number alone.
Q2 (Calculate)
Show formula substitution; cite chapter numbers.
Q3 (Application)
Both must align — strong Graham Number with weak BVPS (or vice versa) needs deeper AR review.
Q4 (Red Flag)
Graham Number alone ignores debt, cash flow, and business quality — triangulate before deciding.
Q5 (CFA Style)
Using Graham Number on IT/brand businesses where book value understates economic value.
Q6 (Decision)
Justify with metric trend + valuation + balance-sheet quality; one ratio never enough.
Q7 (Lab)
See Part 04 Practice Lab and verify with lab Answer Key.
Go deeper: Part 04 Practice Lab
FAQ {#faq}
Q: What should I check alongside Graham Number screening?
A: ROCE, debt trend, cash flow, and Altman Z — Graham Number alone does not confirm value.
Q: How do I connect theory to Indian market practice?
A: Use Screener/Trendlyne + company annual reports — plot the same metrics over 3 years; paper formulas alone are insufficient.
Q: Why avoid buying based on Graham Number alone?
A: It ignores business quality, leverage, and cash flow — a classic value-trap screen.
Q: Why avoid a negative cash flow company with a low Graham Number?
A: Accounting earnings without cash support undermine the fair-value estimate.
Q: How do I drill these concepts in the Practice Lab?
A: Open Part 04 Practice Lab → use the FAQ Drill row for graham-number-formula to practice on real stocks, then verify answers against the Chapter FAQ Quick Index.
Practice Lab FAQ: Full part FAQ index — Part 04 Practice Lab
Related Topics
- Previous Chapter: 29-Margin Of Safety
- Next Chapter: 31-Intrinsic Value
- Part Overview: Part 04 Value Investing
- Book Index: Full Table of Contents
Disclaimer: Educational content only. Not investment advice. Consult a qualified financial advisor before investing.