Graham Index, also known as Graham number in English, is a value indicator that measures the level of stock prices. Benjamin Graham published his famous book "The Intelligent Investor" in 1949, introducing his investment philosophy to the world. In this book, Benjamin Graham proposed a stock price measurement, the Graham Index, which provided a stock selection criterion for defensive investors and narrowed the scope of stock selection for investors. The index measures whether a company's stock price is overvalued or undervalued by combining its earnings per share and book value per share. When a company's stock price is lower than its Graham Index, it is generally considered that the stock price is undervalued, which means it may become a good investment. When the company's stock price is higher than its Graham Index, it means that the company's stock price is overvalued, and investing blindly may result in losses. In actual use, the Graham Index has certain usage restrictions. The company's price-to-earnings ratio (P/E Ratio) should be less than 15, and the price-to-book ratio (P/B Ratio) should be less than 1.5, otherwise it will not be applicable to the Graham Index. At the same time, the Graham Index is not suitable for unprofitable companies, because the earnings per share of such companies may be negative, so it cannot provide guidance. The second formula better illustrates the limitations of using the Graham Index. Earnings per share must be less than 15, and book value per share must be less than 1.5. Otherwise, the Graham Index cannot be used to accurately measure whether the company's stock price is overvalued or undervalued. Among them: Earnings per share is net income divided by the number of shares outstanding, which is: Earnings per share = Net income / Number of shares outstanding Earnings Per Share (EPS) = Net Income / Shares Outstanding Book value per share is shareholder equity divided by the number of outstanding shares and represents the minimum value of a company's equity, which is: Book value per share = shareholders’ equity / outstanding shares Book Value Per Share (BVPS) = Shareholder’s Equity / Shares Outstanding Net income and number of shares outstanding can be found in the company’s consolidated statement of operations (STATEMENTS OF OPERATIONS), and stockholders’ equity can be found in the company’s statement of stockholders’ equity (STATEMENTS OF SHAREHOLDERS’ EQUITY). How to calculate Apple's Graham Index? This chapter will perform example calculations using Apple's 10-K financial report released in September 2021: The consolidated statement of operations and statement of stockholders' equity in AAPL's financial report are as follows: As you can see from the datasheet: In fiscal year 2021, Apple's Net Income was $94,680M, the number of outstanding shares was 16,701,272K, and shareholders' equity was $63,090M. So: = $94,680 M / 16,701,272 K = $5.67 = $63,090 M / 16,701,272 K = $3.78 Graham Index = (22.5 x earnings per share x book value per share)1/2 Graham number = (22.5 x EPS x BVPS) 1/2 = (22.5 x 5.67 x 3.78)1/2 = 21.96 Therefore, Apple's current Graham Index is 21.96. However, because during the calculation process, Apple's book value per share was 3.78, which was greater than 1.5, so according to the concept of the Graham Index, it is not currently suitable to use the Graham Index to evaluate whether Apple's stock price is overvalued or undervalued. What investment guidance does the Graham Index have? Benjamin Graham believed that the more investors paid for a stock, the lower the return they would receive, so when a company's stock price is lower than the current Graham Index, it is considered a price that can be invested and purchased. It can also be understood that the Graham Index provides an upper limit for the purchase price of a specific stock.
Similarly, the Graham Index can also be used to determine whether a company's current stock price is overvalued or undervalued: If the company's stock price is higher than the Graham Index, it is considered that the company's stock price is overvalued and has little investment value; If the company's stock price is lower than the Graham Index, it is considered that the company's stock price is undervalued and has better investment value. What are the limitations of using the Graham Index? The Graham Index is suitable for profitable companies, because when a company is not profitable, its earnings per share may be negative, which loses calculation meaning. The Graham Index does not apply to companies with earnings per share greater than 15 and book value per share greater than 1.5. Because the Graham Index only uses two simple values, there will be a certain degree of bias when evaluating a company's value. If investors need to accurately measure the difference between a company's stock price and its true value, more indicators need to be used for a comprehensive evaluation. More company valuations What are minority interests? How to handle the profits of subsidiaries? What is Shareholders’ Equity? Shareholders’ Equity What is the Price to Cash Ratio (P/CF)? How to calculate? What is Operating Expense OpEx? Operating Expenses What is Cost of Goods Sold (COGS)? How to calculate? What is company profit? Gross profit, operating profit, net profit What is enterprise value multiple? Enterprise Multiple What are preferred shares? Preferred Stock What is operating leverage? Degree of Operating Leverage What is debt service ratio? Debt Service Coverage Ratio