# How to Value a Stock with the Benjamin Graham Formula

Written by

Jae Jun

#### Quick Word on the Science and Art of Valuation

Valuation is an art.

Assumptions are needed to perform any type of analysis as the whole topic of stock valuation is forward looking.

Throughout these valuation exercises, it’s important to understand that the final stock value will vary based on the assumption of scenarios.

Instead of trying to pinpoint one number, the science behind valuing stocks is to come up with a range of values. By doing so, it helps you to think about the downside as well as the upside possibilities.

Now, let’s see how Graham valued stocks.

#### Using Benjamin Graham’s Formula to Value a Stock

The Benjamin Graham Formula was Created by this man.

The second method I use to value a stock is by using Benjamin Graham’s formula from The Intelligent Investor.

With the extremely popular free Ben Graham stock spreadsheet I offer, the stock valuation method deserves a closer look.

#### Benjamin Graham Formula

The original formula from Security Analysis is

where V is the intrinsic value, EPS is the trailing 12 month EPS, 8.5 is the PE ratio of a stock with 0% growth and g being the growth rate for the next 7-10 years.

However, this formula was later revised as Graham included a required rate of return.

The formula is essentially the same except the number 4.4 is what Graham determined to be his minimum required rate of return. At the time of around 1962 when Graham was publicizing his works, the risk free interest rate was 4.4% but to adjust to the present, we divide this number by today’s AAA corporate bond rate, represented by Y in the formula above.

(credit to wikipedia for the formula images)

But intrinsic value shouldn’t be calculated based on a single 12 month period which is why I have the EPS automatically adjusted to a normalized number ignoring one time huge or depressed earnings based on 5 year or 10 year history depending on the company you are looking at.

EPS is never really a good number on its own as it is highly prone to manipulation with modern accounting methods. Another reason why you have to always normalize EPS is because management will never understate earnings on purpose. While companies may follow accounting procedures which inflates earnings, they will never go out of their way to make it lower than it is.

Another variation of the formula will use the projected EPS but unless it is a pure growth stock with exponential growth like characteristics, the stock value will become absurdly high.

EPS by analysts are also always over optimistic, so by following Wall Street guidance, you’re starting off on the wrong foot.

The drawback of the Benjamin Graham formula is that growth is a big element of the overall valuation.

You can change 8.5 to whatever you feel is the correct PE for a no growth company. Depending on your conservativeness, anything between 7 and 8.5 should be fine.

For the actual growth rate, if convenience is important, you could just use the analyst 5yr predictions from Yahoo or other sites, but for most value stocks that I search for, predictability is important so a regression of the historical EPS to project the following year is a method I like to use.

The “2 x G” however, is quite aggressive. So I’ve recently reduced the multiplier to 1.5 instead of 2.

#### Corporate Bond Rate

I currently have the stock value spreadsheet set up to use the 20 year A corporate rate which is just above 6%. This provides a slightly more conservative intrinsic value than the 20 year AAA or AA.

#### Final Adjusted Benjamin Graham Formula

So by making the adjustments, the new formula is now

#### Testing the Formula

Testing this equation on Microsoft, the inputs are

• Normalized EPS = \$1.40
• g = 12.6%
• Y = 6.05%

which results in an Ben Graham intrinsic value of \$29.10. Current price as of writing is \$29.41.

Results look pretty good, but not all companies are as predictable or stable as MSFT so the stock valuation could be a coincidence.

A growing company DLB.

• Normalized EPS = \$2.1
• g = 17%
• Y = 6.05%
• Intrinsic value = \$53.56
• Current price = \$44.72

• Normalized EPS = \$7.6
• g = 18.6%
• Y = 6.05%
• Intrinsic value = \$207.41 (much different to my dcf valuation of AAPL)
• Current price = \$199.91

The results aren’t all too bad but obviously, you will need to be careful of your inputs. And never forget margin of safety.

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#### Disclosure

No positions at time of writing.

• Ryan B

Hi Jae, instead of using normalized EPS what about owner earnings per share?

• Andrew

Hey Jae, no matter how I plug in the numbers in the examples I cannot get the correct intrinsic value from the examples.

For the MSFT valuation it should be V = [1.4 (7 + 1.5(12.6)) x 4.4]/6.05

Please correct me if I am mistaken!

• http://www.oldschoolvalue.com Jae Jun

@ Ryan
I never thought about trying it with owner earnings. I don’t see why it won’t work. Use the normalized owner earnings and use the owner earnings growth rate and plug it in the formula. I’m gonna try it right now and see what I get.

• http://www.oldschoolvalue.com Jae Jun

@ Andrew

Keep in mind that the formula looks real simple but you need to expand it.

If I expand the numerator it becomes

4.4*EPS*8.5 + 4.4*EPS*2g

then divide the whole thing by 6.05.

In excel the formula is
=1.4*(7+(1.5*12.6)*(4.4/6.05))

• Andrew

why did my last comment get deleted?

• Andrew

Jae, I plugged in the numbers to both of your equations and results are the same as what I have calculated, 26.37 and not 29.10.

• http://www.oldschoolvalue.com Jae Jun

Andrew,

I think you’re making a mistake with the order of operations somewhere.

Just enter “=1.4*(7+(1.5*12.6)*(4.4/6.05))” into excel and you will get the number.

I didn’t delete any comments by the way.

• Andrew

Hi Jae, thanks for the clarification, I got the same number using 1.4*(7+(1.5*12.6)*(4.4/6.05)). Just wanted to point out V= [EPS*(7*1.5g)*4.4]/Y (the equation you have on top) is not the same as the formula you provided in the excel!

• http://www.oldschoolvalue.com Jae Jun

Andrew,

You’re right!
I made the mistake and never re-checked it after all this time.

Thanks for pointing it out. I’ll fix it and send it out in the next update.

• David Ng

hi jae, although i feel okay with your adjustments to the formula. but then intrinsically, you’re changing benjamin graham’s formula. as we all know, buffett is the most disciplined follower of graham. if you take a look at his recent BNI acquisition. buffett still uses graham’s formula to place a value on BNI. we get a value around \$93 and buffett paid \$100.

when you adjust your formula. we get a value for BNI around \$65. then would you be suggesting that buffett overpaid for BNI (which is not his usual practice)?

• http://www.oldschoolvalue.com Jae Jun

David,

Based on my assumptions, Buffett wouldn’t use Graham’s formula as it depends heavily on EPS which is something Buffett has clearly expressed is not correct. Even if he decided to use his Owner earnings as the EPS, that still changed the formula.

The formula is only guide. There is no right and wrong way, but for my investing, the standard Graham formula is not correct.

BNI is a very different story and is much deeper than a valuation. Buffett bought it as an inflation protection investment as well as its hidden assets which is not shown on the balance sheet.

So on paper, I think he overpaid, but in reality, he probably got a good deal. Also remember his See’s Candies purchase was not a cheap one at the time.

• Luke

Hi jae,

just wanted to know if Grahams formula can be used for UK stocks?

Great site by the way.

• http://www.oldschoolvalue.com Jae Jun

Luke,

Yes the formula works for all companies

• JMRojo82

Good post. I have 3 questions.
1) Does “The Intelligent Investor” explain the methodology behind the variables in the formula, specifically why was 2 used in 2g (ie – I understand 2 is modifying the PE ratio to reflect the growth rate, but what makes 2 the magic number to adjust the growth rate? or 1.5 for that matter)
2) Why are we multiplying the percentages by 100 (ie 12% is 12 in your formula and not .12)?
3) Can you explain the original equation is multiplied by 4.4%/y. I see your explanation above, but don’t follow the mathematical relationship.
If all of this is covered in Grahm’s book, then just tell me to defer to the book.
Thanks,
-Rojo

• MJ

Actually Buffett ended up paying about \$93/share for BNI if you include the 22% he bought on the open market before the buyout offer. Those shares were purchased at a cost basis of something like \$75.

• Michael

Who are you?

• Michael

…Andrew, that is.

• C

I’d like to point out that the calculations on this page are incorrect.

=1,4*(7+(1,5*12,6)*(4,4/6,05))

it should be:
=1,4*(7+(1,5*12,6))*(4,4/6,05)

• Imran

Dear Jae,
At the outset, I would thank you to provide us with such a valuable source of investment information. I am hugely fascinated by your excel spreadsheet intrinsic value calculator. However, my problem is that I am in India and I do not know a database from where I could pull up the data nto your spreadsheet (after i buy it). Could you please somehow use your research and help me with this problem. Secondly, I have personally developed a Graham formula and DCF valuation worksheet, where my biggest problem is the calculation of growth rate. My question is that whether five years growth data of free cash flow would be enough to arrive at a meaningful value of the stock. Any more suggestions would be helpful. Thanks.

• http://www.oldschoolvalue.com Jae Jun

@ Imran,

As far as I know, there is no other country in the world that offers the level of transparency required by public companies as well as the vast amount of resources available by 3rd party sites.

Regarding the growth rate calculation, it is very subjective but you wouldn’t want to use the FCF growth rate for the graham calculation because the Graham formula is based off earnings. You would have to use the EPS growth for that.

• aku

Do people use Ben Graham Method in real life to do stock valuations?

• http://www.oldschoolvalue.com Jae Jun

Yes sure do. It’s a decent method.

• Sam Ho

I see that you used normalized EPS here but estimated EPS in ur spreadsheet?

which one do u prefer in what scenario? does it depend on Rsquare?

Thank You

• Sujal

Hi, I liked your explanation. But can you help me to figure out equation for Indian market. I’m from india. In India, corporate bond is interest rate is around 9.5 to 10%. AAA bond yield will come around 11.5% so what should be my equation for calculating intrinsic value = (EPS * (7 + (1.5*G))*9.5)/11.

Is it correct ? Please help me to solve this. And my modification is correct or still i should use either original or your modified formula ?

• http://www.actioninvestmentmgt.com jalleninvest

Graham added a warning to his discussion of this formula in The Intelligent Investor:

“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.”

Graham, Benjamin; Jason Zweig; Warren E. Buffett (2009-03-17). The Intelligent Investor, Rev. Ed (Kindle Locations 4359-4362). HarperCollins e-books. Kindle Edition.

• Burak

It is funny to see people here discussing a formula that wont help them. You can get every possible value for this formula. This formula is only usable if you have businnes experience and so know what factors are relevant for the growth rate. Believe me: 95% of you dont know how to use it correctly.
In real this formula is only a product of a more useful formula that gives back the intrinsic value with a certainity of 100 percent.
I dont know if Graham knew this other formula. I can imagine he did but he didnt tell. Why should he? Why should Warren Buffett tell you the core of his knowledge or the “moat” like he would say.
If you want to learn this formula you must read read read, i give you 7 years, therein you will may be able to create this simple formula.
Unfortunatelly i wont tell you, like Buffett wont tell you, too. This formula is the real “moat” that makes me one of the 5% winning, and the others 95% loosing and wasting their time with Graham´s formula, which give too much room for interpretation for 95% of people dont knowing which rate to use.
I hope you see me one day next to the greatest investors. I hope you dont waste your time with this formulas. You should read day and night books about economics and businesses, like i did many years. There are no secrets, many years of reading can give you key information that you will never find on google, or in any formula book, or chats or sites like this.

• http://www.oldschoolvalue.com Jae Jun

I believe you mean to be helpful, but to me it just comes across as arrogant.
There are a category of people in the world like Graham who just enjoy teaching and sharing without wanting anything in return. These people just have an abundant wealth of knowledge from all the reading they have done, and go out of their way to teach and share. How do I know? Because I know several of these people first hand.

Just believing that reading will help you is useless. Without discussion and application, it’s nothing but wasted words. That’s the key.

• Hieu

How do you get the growth rate (g) ?

• http://www.oldschoolvalue.com Jae Jun

growth rate is calculated based on historical returns. If the growth rate seems incorrect, you also have the option of overriding it with your own value.

• Steve

Historical return means revenue or Net profit?

• http://www.oldschoolvalue.com Jae Jun

growth rate based on historical EPS values

• Andy

How do you calculate the normalized EPS?
Average return on equity (ROE) form most recent full cycle * current book value per share?
Can you Please give an example for your normalized EPS and data source?
Thank you,
Andy

• okiwa

1. Lease Offering Company (LOC) has issued a 5-years bond with par value of Rs. 1,000 at
coupon of 11.8% per annum payable semi-annual. The bond was issued at discount and
currently trading at Rs.865. For a risk averse, required rate of return is 13.5% for this bond.
Credit Rated Agency (CRA) has recently rated this bond at BBB – moderate.
2. Titanic Transportation has issued a 5-years bond at a coupon of 17% per annum payable semiannual.
The bond with par value of Rs.1,000 is currently trading at Rs.1,080. For a risk taker,
this bond has an opportunity cost of 14%. CRA has rated it at B – highly speculative.
3. Saman Textile’s common stock is selling at Rs.88 per share in the stock market. The company
has recently paid Rs.6 per share as dividend. The dividend is expected to grow at 7% for
foreseeable future. For a rational investor, this share can be purchased at a cost of 14%.
4. Abuzar Sugar’s dividend is expected to grow at 8% for foreseeable future and currently they are
paying Rs.8.50 per share as dividend. The company is rated as a blue chip in the stock market.
Currently the share is trading at Rs.100 each. A sharp Investors is ready to invest in this share at
a require return of 16%.
1. Calculate intrinsic value of the above securities

• http://www.oldschoolvalue.com Jae Jun

Hi okiwa,

Do you own these companies and just want to see what the calculated value is?

• Theodore Petrara

Burak-

• Alberto

Hi Jae,

May I ask you a question?

Can you please post the url of yahoo website where you take the ”analyst 5yr predictions” for Microsoft?

Thank you,
Alberto

• Casimir

Hi, Why Benjamin choosen 2G and not 1.5G or 1G ? What mean 2 ?

• http://www.oldschoolvalue.com Jae Jun

2 x G was chosen because at that time, growth was much lower than today.

• cinnabar

If you listen to Warren Buffett talk about Ben Graham, he says that Graham ran the partnership purely based on the things he wrote in his book, without any use of knowledge, expertise, or connections that they may have had. It drove Buffett crazy!

• geisslingen

Hello Jae,

I am new to the art of value investing and I am using your wonderful spreadsheet to evaluate a group of company stocks that I hope to add to my portfolio in near future. I have 3 questions for you and I hope you have the time to reply:

1. Why financial stock, banks, etc. are not supported in your spreadsheet?

2. When I run a stock using DCF and Graham methods, I get more realistic valuations with the later than the DCF which sometimes will calculate a -ve company stock valuation. Why is that so and can I just use the Ben Graham method to evaluate large cap companies?

3. What do the company stock quality indicators mean? and what are the red flags when I read the Piotroski Score, what are the thresholds that an investor should look for?

Thanks

• http://www.oldschoolvalue.com/ Old School Value

1. financials use a different GAAP statement. This means their financial statement line items are completely different.

2. DCF is for cash flow companies. If you try to value capex heavy companies, it won’t work unless you adjust the numbers. Growth stocks with little cash won’t work because DCF values a stock based on the FCF.

3. Piotroski score is showing the accounting health of a company. Higher the better. You dont want a company to start decreasing to 4-5.
Refer to this page to see a list of articles on how to value stocks.
http://www.oldschoolvalue.com/blog/stock-valuation-methods-calculate-intrinsic-value/

• Max

could you please name the source for the revised formula?

• Zach

Hello Jae,

Thank you for making this information explicit and easy to understand for all. My question may be simple, but I could not find it addressed anywhere on the OSV blog… I understand that “normalizing” EPS over 5-10 years is safer than just basing your calculations on a single 12 month EPS. However, you never explicitly state how you normalize EPS. Is this just a 5-10 year average of EPS? Any help on this would be fantastic. Ciao

• http://www.oldschoolvalue.com/ Old School Value

Hi Zach,

The easiest way is to average.
For a better way, the FULL explanation is provided in the valuation ebook.
try.oldschoolvalue.com/the-ultimate-guide-to-stock-valuation/

• jojo

Hi Jae,
I modify Graham’s growth formula for Singapore stocks accordingly, using your modified version and its underlying assumptions :-
IV = EPS x (7 + (1 x EPS growth)) x 10yr SG govt bond rate

Given that the 4.4 risk-free rate in Graham’s original formula is USA-centric in 1962 and SG has no 20yr AAA corporate bond rate, I figure that the only minimum rate of return I can use is the 10yr SG govt bond rate.

Appreciate if you could pls share your opinion on my modified Graham’s growth formula for SG stocks valuation – does it make sense to you?
Hope to get your opinion soon.

Thanks.

• jojo

Hi Jae,
Another question, why do you use next Financial Year’s EPS forecast as the starting point for Graham’s valuation?
In your e-stock valuation pdf book, you explained that EPS used in Graham’s formula is the TTM EPS, but in your spreadsheet, it is the following year’s EPS estimate depending on the method chosen (forecast, linear regression, or analyst estimate). Shouldn’t the TTM EPS be used instead of the following year/s EPS estimate?
I am still a newbie trying to understand the logic behind the formula & nos, and aligning them to your e-valuation book.
Hope to hear from you soon, and thanks in advance.

• http://www.oldschoolvalue.com/ Old School Value

hi jojo

Yes that is fine. I used to use the 20yr A bond rate for a more conservative estimate. A 10 yr rate should do. Also, best thing is to test with many stocks and see how it turns out.

• http://www.oldschoolvalue.com/ Old School Value

The idea is really two fold.

There are companies where you can use the TTM EPS, and companies where you can’t.

Stocks showing good growth should use a forward estimate. In the spreadsheet, I use the past performance to forecast the future EPS.

The quick and easy way is to just use the past EPS.

A company like KO, you can get by easily. But for a growing company, or one where the growth has slowed, it is important to be flexible in your valuations to use a different value. One that is more indicative of the future.

• Deepak Kumar

Im using this formula with lot of sensable modifications from months have tried them on many companies including petrochina and current exxon mobile, and im amazed with the result, this formula is wrong in short. mark me an email i would like to discuss my finding with you deepak.jindal07 at gmail

• http://www.oldschoolvalue.com/ Old School Value

would be interested in hearing your thoughts by adding to this thread where we discuss the graham formula. http://www.oldschoolvalue.com/forum/discussion/comment/5215

• Newbie

Hi Jae, Thank you for this post. As a starter, “newbie” I find it very helpful. Learned a lot. One suggestion, can you go more on details in explanation? And maybe some of your tests as example if it is not a secret. Well, good job and waiting for some more interesting lessons.

• G.T.

What if the EPS or Growth rate for a company is negative? By Benjamin’s formula (described here), you will get a negative value for the stock, so what is best to do in that case (to avoid negative value)?

• moatfrog

You are one of the more, perhaps most, arrogant commentator I have come across — so arrogant as to be ignorant. Sorry I wasted the time with you.

• Lim

If the company has a negative EPS, I would look at some other company to invest in. Good companies are consistently profitable and need to be predictable.

• http://www.oldschoolvalue.com/ Old School Value

or what you can do is normalize it.

Get the forecasted net margin.
Multiply net margin to the forecast revenue to get the forecasted EPS.

Then use that number in the Graham formula.