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Saturday, February 19, 2011

Benjamin Graham: The Godfather of Value Investing's Secret Formula

Benjamin Graham, the godfather of value investing and Warren Buffett's mentor, has a secret formula on value investing.

The Graham Number:

Fair Value of a Stock = Square Root of (22.5) x (Earnings Per Share) x (Book Value Per Share)

The math of the Graham number is relatively straightforward. Graham believed that the price-to-earnings (P/EPS) ratio should be no more than 15. He also believed that the price-to-book value (P/BVPS) ratio should be no more than 1.5.

From that, Graham proposed that -- as a rule of thumb -- the product of the two should not be more than 22.5. In other words, (P/EPS of 15) x (P/BVPS of 1.5) = 22.5.

Read more on Graham Number here.

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