As a dividend Investor, we are not only searching for a stock that distributes an awesome dividend every year but also to find a stock that may be undervalued. This will boost up our return in the future.
If you are a subscriber of the Truly Rich Club of Bo Sanchez, you are guided to buy a stock only at a price recommended by the buy below price base on the fair value of the stock. Here in the dividend observer site, I will give you a guide to how much maximum price you need to pay for a dividend stock. Since I am not yet fully equipped with the in-depth analysis on how to value stocks, I am using Graham Number to identify stocks that may be undervalued. The Graham number is an easy metric to use as a screen to avoid paying too much high price for a stock.
So, How to Calculate Graham Number?
The Graham Number is very simple and easy to calculate. We only need the company earnings and book value to acquire the number. Here’s the formula:
Graham Number = Square Root of [22.5 x Earnings Per Share (EPS) x Book Value Per Share (BVPS)]
Earnings Per Share (EPS) is the average of the past 3 years earnings.
Book Value Per Share (BVPS) = Shareholder Equity / Total Outstanding Common Shares
22.5 = the number set by Graham; it is the product of his maximum P/E ratio (15) and his maximum Book Value Per Share (1.5).
Warning: The Graham Number is the maximum price to pay for a stock and must be used in relation with other metrics (it can be used to compare dividend stocks and eliminate the most expensive for further research). Further, the Graham Number does not work well on growth stocks, companies with negative earnings, or companies with limited tangible assets (i.e cash, land, buildings, equipment, etc.).
Let’s take a look on Aboitiz Equity Ventures, Inc (AEV) as our example to calculate the Graham number.
Earnings Per Share (EPS):
2014 EPS = Php3.32
2013 EPS = Php3.81
2012 EPS = Php4.34
3 Year Average = Php3.82
Book Value Per Share (BVPS) = Php19.49
AEV market price as of April 21, 2015 = Php57.85
Graham Number = Square Root of [22.5 x 3.82 x 19.49] = Php40.95
Conclusion: Since the price (Php57.85) of AEV is significantly higher than the Graham Number (Php40.95), it is not commendable candidate to conduct for further research.
Let’s take another example: Union Bank of the Philippines, Inc (UBP)
Earnings Per Share (EPS):
2014 EPS = Php7.94
2013 EPS = Php8.53
2012 EPS = Php7.19
3 Year Average = Php7.89
Book Value Per Share (BVPS) = Php52.76
UBP market price as of April 21, 2015 = Php69.00
Graham Number = Square Root of [22.5 x 7.89 x 52.76] = Php96.76
Conclusion: Since the price (Php69.00) of UBP is significantly lower than the Graham Number (Php96.76), it is a prime candidate to conduct further research.
It’s really easy, right? In the following days, I will start updating the dividend stocks that are undervalued base on Graham number. Please come back later to find out which stocks deserve to be in your portfolio.
Thank you for reading and may you achieve Financial Independence sooner than later!