Benjamin Graham Intrinsic Value Formula


Benjamin Graham Intrinsic Value Formula

V = (EPS * (8.5 + 2g) * 4.4)) / Y

This formula is taken from the Intelligent Investor by Benjamin Graham. The formula was revised in 1974 to include 4.4 and to divide by Y the current yield of AAA corporate bonds. . Graham suggested a very simple formula for the evaluation of stocks.

  • V: Intrinsic Value
  • EPS: the company’s last 12-month earnings per share
  • 8.5: the constant represents the appropriate P-E ratio for a no-growth company as proposed by Graham
  • g: the company’s long-term (five years) earnings growth estimate
  • 4.4: the average yield of high-grade corporate bonds in 1962, when this model was introduced this was 4.4
  • Y: the current yield on AAA corporate bonds We suggest the following page for obtaining bond rates for today: Bloomberg Corporate Bonds

A stocks’ intrinsic value V can be divided by its current stock price, V divided by P where P is current price. If the result is greater than 1 then the stock is undervalued, If it is less than 1 it is overvalued. This is intended as a back of an envelope calculation. It is an incredibly simplistic value and does not account for the following:

  • Net Current Asset Value
  • Current Asset Value
  • Debt to equity ratio
  • Quality of the Current Assets

Graham provides a disclaimer with the simple calculation: This material is supplied for illustrative purposes only, and because of the inescapable necessity in security analysis to project the future growth rate for most companies studied. Let the reader not be misled into thinking that such projections have any high degree of reliability or, conversely, that future prices can be counted on to behave accordingly as the prophecies are realized, surpassed, or disappointed.

Example IBM 

Data as of 1/13/2013

Earnings Per Share (Trailing Twelve Months) = $14.44

G Growth rate = 10% ($8.93 per share earnings in 2008 to 14.44 in 2013 is actually more but we’ll keep it simple)

Y = 4.6% AAA Corporate Bond Investment Grade yield according to Moody

V = (14.44 * ((8.5 + 2(10)) * 4.4) / 4.6

V = Intrinsic Value = ~$393.6

IBM Current Price (1/13/2014) = 184.16 = $393.6/$184.16 = 2.137 As this is greater than 1 it is undervalued.

Now obviously if IBM’s growth rate per were to be lower then 10%, this valuation would be wrong. We’re simply using the past 5 years of earnings per share growth rounded down. Past performance does not dictate future performance and we don’t know for sure what IBM’s growth will be in the future. (This is a pure example not any belief in IBM)

This does not constitute advice to invest in International Business Machines (IBM) nor are the assumptions here listed treated to be fact but an example of the investment process and the adjustments made.