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Benjamin Graham Formula: The Original Value Investing Method

Learn Benjamin Graham's stock valuation formula, how to calculate the Graham Number, and how the father of value investing determined fair price for stocks.

Meet Dhanani
By Meet Dhanani

Senior Software Engineer at Red Hat

Benjamin Graham is the father of value investing. His formulas, developed in the 1930s-1960s, remain relevant nearly a century later because they capture timeless principles: don’t overpay, demand a margin of safety, and focus on tangible value over speculation.

This guide covers Graham’s two primary valuation formulas and how to apply them today.

Formula 1: The Graham Number

The Graham Number sets the maximum price a defensive (conservative) investor should pay for a stock. It combines two fundamental metrics: earnings power (EPS) and asset backing (book value).

The Formula

Graham Number = √(22.5 × EPS × Book Value Per Share)

Where:

  • EPS = Earnings Per Share (trailing 12 months, positive only)
  • Book Value Per Share = (Total Assets - Total Liabilities) / Shares Outstanding
  • 22.5 = Graham’s multiplier, derived from P/E of 15 × P/B of 1.5

The Logic Behind 22.5

Graham believed a defensive investor should never pay more than:

  • 15x earnings (moderate P/E for a stable company)
  • 1.5x book value (modest premium to net assets)

The product 15 × 1.5 = 22.5 becomes the constant in the formula. By taking the square root of (22.5 × EPS × BVPS), you get a price that satisfies both constraints simultaneously.

Example Calculation

Company A:

  • EPS: $8.50
  • Book Value Per Share: $52.00
  • Graham Number: √(22.5 × 8.50 × 52.00) = √(9,945) = $99.72

If Company A trades at $78, it’s below the Graham Number, passing Graham’s conservative screen.

Company B:

  • EPS: $3.20
  • Book Value Per Share: $15.00
  • Graham Number: √(22.5 × 3.20 × 15.00) = √(1,080) = $32.86

If Company B trades at $45, it exceeds the Graham Number (too expensive by Graham’s standards).

When the Graham Number Works Best

  • Financial companies (banks, insurance) where book value is meaningful
  • Stable, profitable companies with consistent positive earnings
  • Cyclical companies at mid-cycle earnings
  • Screening for deep value candidates in a large universe

When It Fails

  • Technology companies: Intangible assets (software, patents, brand) aren’t reflected in book value
  • High-growth companies: Graham Number ignores growth entirely, making it too conservative for compounders
  • Companies with negative book value: Formula produces an imaginary number
  • Asset-light businesses: Companies like Visa have enormous earnings but tiny book values

Formula 2: Graham’s Growth Formula

Later in his career, Graham developed a more nuanced formula that incorporates growth expectations:

The Formula

Intrinsic Value = EPS × (8.5 + 2g)

Where:

  • EPS = Current earnings per share
  • 8.5 = Base P/E for a zero-growth company
  • g = Expected annual growth rate (%) for next 7-10 years

The Logic

Graham argued that a stock with zero growth deserves a P/E of 8.5 (his 1962 estimate of fair multiple for a static business). Each percentage point of growth adds 2 points to the justified P/E.

Example

  • EPS: $5.00
  • Expected growth rate: 12% per year
  • Intrinsic Value: $5.00 × (8.5 + 2 × 12) = $5.00 × 32.5 = $162.50

Revised Formula (Adjusted for Bond Yields)

Graham later modified the formula to account for interest rates:

Intrinsic Value = [EPS × (8.5 + 2g) × 4.4] / Y

Where:

  • 4.4 = The AAA corporate bond yield when Graham wrote his formula (4.4%)
  • Y = Current AAA corporate bond yield

This adjustment lowers fair value when interest rates rise (bonds become more competitive with stocks) and raises it when rates fall.

Example with Rate Adjustment

  • EPS: $5.00
  • Growth: 12%
  • Current AAA yield: 5.5%
  • Intrinsic Value: [$5 × (8.5 + 24) × 4.4] / 5.5 = $715 / 5.5 = $130.00

The higher interest rate environment reduces fair value from $162.50 to $130.

Graham’s Defensive Investor Criteria

Beyond formulas, Graham laid out qualitative and quantitative filters for stock selection:

Quantitative Screens

  1. Adequate size: Revenue above $500M (adjusted for inflation)
  2. Strong financial condition: Current ratio above 2.0
  3. Earnings stability: Positive earnings in each of the past 10 years
  4. Dividend record: Uninterrupted dividends for at least 20 years
  5. Earnings growth: Minimum 33% increase in EPS over past 10 years
  6. Moderate P/E: Current P/E below 15
  7. Moderate P/B: Price-to-book below 1.5 (or P/E × P/B < 22.5)

How Many Stocks Pass Today?

Very few. In a market with average P/E of 22, most quality companies exceed Graham’s strict P/E limit of 15. This is why many modern value investors use Graham as a starting point but apply less rigid thresholds.

Graham vs. Modern Valuation

Aspect Graham’s Approach Modern Approach
Emphasis Asset protection, tangible book value Cash flow generation, intangibles
Growth treatment Skeptical, minimal weight Central to valuation (DCF)
Technology companies Mostly excluded Core holdings for many
Typical holding period Medium (2-5 years) Long (5-10+ years)
Margin of safety 33%+ required 20-30% common

Applying Graham Today

Graham’s formulas work best as a conservative floor in a multi-model approach:

  1. Calculate the Graham Number: Sets the “never pay more than” ceiling for value stocks
  2. Use the growth formula: For companies with predictable earnings growth
  3. Layer on DCF: For a more comprehensive forward-looking view
  4. Apply margin of safety: Graham would insist on at least 33% discount

Our Graham Number calculator instantly computes the Graham Number for any stock. For a composite view combining Graham with DCF and PEG models, try our intrinsic value calculator.

Graham’s Enduring Wisdom

Graham’s most important contributions aren’t the formulas themselves. They’re the principles:

  1. Mr. Market: The market is your servant, not your guide. It offers prices every day; you decide when they’re attractive.

  2. Margin of Safety: The three most important words in investing. Never pay full price for anything.

  3. Investment vs. Speculation: An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Everything else is speculation.

  4. Be right because your facts and reasoning are right: Not because others agree with you.

These ideas, first published in Security Analysis (1934) and The Intelligent Investor (1949), remain the foundation of value investing practiced by Buffett, Klarman, Greenblatt, and thousands of successful investors worldwide.

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