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{{Short description|Formula for the valuation of growth stocks}}
{{Distinguish|Graham number}}
The ''' Benjamin Graham formula''' is a formula for the [[valuation (finance)|valuation]] of [[growth stock]]s.

It was proposed by investor and professor of [[Columbia University]], [[Benjamin Graham]] - often referred to as the "father of value investing".
<ref>{{Cite book|title=Benjamin Graham: The Father of Value Investing|last=Dave|first=John|publisher=CreateSpace Independent Publishing Platform)|year=2014|isbn=978-1500653743}}</ref>
Published in his book, ''[[The Intelligent Investor]]'', Graham devised the formula for lay investors to help them with valuing growth stocks, in vogue at the time of the formula's publication.
<ref name=":0">{{Cite book|title=The Intelligent Investor: Revised Edition|last=Graham|first=Benjamin|publisher=First Collins Business Essentials|year=2006|isbn=0-06-055566-1|pages=[https://archive.org/details/harrypotterhalfb00rowl_0/page/295 295, 297, 585]|url-access=registration|url=https://archive.org/details/harrypotterhalfb00rowl_0/page/295}}</ref>

Graham cautioned here that the formula was not appropriate for companies with a [[Financial ratio#Debt ratios|"below-par" debt position]]: "My advice to analysts would be to limit your appraisals to enterprises of investment quality, excluding from that category such as do not meet specific criteria of financial strength".<ref>Benjamin Graham (1974). [https://books.google.com/books?id=a14UAQAAMAAJ&q=%22advice+to+analysts+%22+ "The Renaissance of Value"], pg 4</ref>

==Formula calculation==
In Graham's words: "Our study of the various methods has led us to suggest a foreshortened and quite simple formula for the evaluation of [[growth stocks]], which is intended to produce figures fairly close to those resulting from the more refined mathematical calculations."<ref name=":0" />

The formula as described by Graham originally in the 1962 edition of ''[[Security Analysis (book)|Security Analysis]]'', and then again in the 1973 edition of ''[[The Intelligent Investor]]'', is as follows:<ref name=":0" />

:<math>V^* = \mathrm{EPS} \times (8.5 + 2g) </math>

<math>V^*</math> = the value expected from the growth formulas over the next 7 to 10 years 
<math>EPS</math> = trailing twelve months [[earnings per share]] 
<math>8.5</math> = [[pe ratio|P/E]] base for a no-growth company 
<math>g</math> = reasonably expected 7 to 10 year growth rate (see {{slink|Sustainable growth rate#From a financial perspective}})

===Revised formula ===
Graham later revised his formula based on the belief that the greatest contributing factor to stock values (and prices) over the past decade had been interest rates. In 1974, he restated it as follows:<ref>Benjamin Graham, "The Decade 1965-1974: Its significance for Financial Analysts," The Renaissance of Value</ref>

The Graham formula proposes to calculate a company’s [[Intrinsic_value_(finance)#Equity|intrinsic value]] <math>V^*</math> as:

:<math>V^* = \cfrac{\mathrm{EPS} \times (8.5 + 2g) \times 4.4}{Y}</math>

<math>V^*</math> = the value expected from the growth formulas over the next 7 to 10 years 
<math>EPS</math> = the company’s last 12-month earnings per share 
<math>8.5</math> = P/E base for a no-growth company 
<math>g</math> = reasonably expected 7 to 10 Year Growth Rate of EPS 
<math>4.4</math> = the average yield of AAA [[corporate bond]]s in 1962 (Graham did not specify the [[Bond duration|duration]] of the bonds, though it has been asserted that he used 20 year [[Bond credit rating|AAA bonds]] as his benchmark for this variable<ref>{{cite web|title=Benjamin Graham's Valuation Formula for Growth Stocks|url=http://www.stockopedia.com/content/benjamin-grahams-valuation-formula-for-growth-stocks-60732/#sthash.1U5l33mj.dpuf}}</ref>) 
<math>Y</math> = the [[current yield]] on AAA corporate bonds.

==Application==
In ''The Intelligent Investor'', Graham was careful to include a footnote that this formula was not being recommended for use by investors — rather, it was to model the expected results of other growth formulas popular at the time.<ref name=":0" />

However, a misconception arose that he was using this formula in his daily work due to a later reprinted edition's decision to move footnotes to the back of the book, where fewer readers searched for them.<ref>{{Cite web|url=https://www.grahamvalue.com/article/understanding-benjamin-graham-formula-correctly|title=Understanding The Benjamin Graham Formula Correctly {{!}} GrahamValue|website=www.grahamvalue.com|language=en|access-date=2017-07-18}}</ref> Readers who continued on in the chapter would have found Graham stating:
:''Warning'': This material is supplied for illustrative purposes only, and because of the inescapable necessity of security analysis to project the future growth rate for most companies studied. Let the reader not be mislead 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.
The movement of the footnote in the reprint has led to an assortment of advisers and investors recommending this formula (or revised versions of it) to the public at large — a practice that continues to this day.<ref name=":0" /><ref>{{cite web|url=http://www.joshuakennon.com/benjamin-graham-intrinsic-value-formula/|title=Benjamin Graham Intrinsic Value Formula|date=15 July 2011|publisher=Kennon & Green Press, LLC|work=Joshua Kennon blog|access-date=14 April 2012|author=Joshua Kennon}}</ref><ref>{{Cite news|url=https://www.oldschoolvalue.com/blog/valuation-methods/value-stocks-benjamin-graham-formula/|title=How to Value a Stock with the Benjamin Graham Formula|date=2017-01-30|work=The Value Investing Blog of Old School Value|access-date=2017-07-20|language=en-US}}</ref> [[Benjamin Clark (investor)|Benjamin Clark]], the founder of the blog and investment service [[ModernGraham]], acknowledges the footnote and argues that "I consider the footnote to be more of a reminder from Graham that the calculation of an intrinsic value is not an exact science and cannot be done with 100% certainty."<ref name="moderngraham.com">{{Cite web|url=http://www.moderngraham.com/2015/09/09/how-to-tell-the-difference-between-the-graham-formula-and-the-graham-number/|title=How to Tell the Difference Between the Graham Formula and the Graham Number|date=2015-09-09|website=ModernGraham|access-date=2017-07-18|archive-date=2017-08-03|archive-url=https://web.archive.org/web/20170803184724/http://www.moderngraham.com/2015/09/09/how-to-tell-the-difference-between-the-graham-formula-and-the-graham-number/|url-status=dead}}</ref> Clark further explains that the formula "is to be used for estimating intrinsic value within a margin of safety which will accommodate the possibility of error in calculation."<ref name="moderngraham.com"/>

Graham also cautioned that his calculations were not perfect, even in the time period for which it was published, noting in the 1973 edition of ''[[The Intelligent Investor]]'': "We should have added caution somewhat as follows: The valuations of expected high-growth stocks are necessarily on the low side, if we were to assume these growth rates will actually be realized." He continued on to point out that if a stock were to be assumed to grow forever, its value would be infinite.<ref name=":0" />
== See also ==
* [[Altman Z-score]]
* [[Beneish M-score]]
* [[Ohlson O-score]]
* [[Fundamental analysis]]
* [[Magic formula investing]]
* [[Value investing]]
* [[TMAI]]
* [[FPI - Fundamental Power Index]]

==References==
{{reflist}}

{{DEFAULTSORT:Benjamin Graham Formula}}
[[Category:Valuation (finance)]]
[[Category:Stock market]]
[[Category:Investment]]

Benjamin Graham formula - Revision history

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