In Chapter 14 of The Intelligent Investor, Benjamin Graham lays out a detailed method for determining whether a stock is "defensive," meaning that it has a significant margin of safety. The analysis touches on the following points:
The Company Must Trade Below Its Fair Value
We use Benjamin Graham's so-called “Graham number” to calculate the fair price of a stock. The Graham number is the square root of (22.5 x earnings per share x book value per share), which for BlackRock gives us a fair price of $448.21. In comparison, the stock’s market price is $709.54 per share. Therefore, BlackRock’s market price exceeds the upper bound that a prudent investor would pay for its shares by 58.3%.
Sales Revenue Should Be No Less Than $100 million.
For BlackRock, average sales revenue over the last few years has been $16,079,000,000.00, so according to the analysis the stock has impressive sales revenue.
Current Assets Should Be at Least Twice Current Liabilities.
We calculate BlackRock's current ratio by dividing its total current assets of $20,629,000,000.00 by its total current liabilities of $12,337,000,000.00. Current assets refer to company assets that can be transferred into cash within one year, such as accounts receivable, inventory, and liquid financial instruments. Current liabilities, on the other hand, refer to those that will come due within one year. BlackRock’s current assets outweigh its current liabilities by a factor of 1.7 only.
The Company’s Long-term Debt Should Not Exceed its Net Current Assets
This means that its ratio of debt to net current assets should be 1 or less. Since BlackRock’s debt ratio is 0.8, the company has healthy debt levels. We calculate BlackRock’s debt to net current assets ratio by dividing its total long term of debt of $6,696,000,000.00 by its current assets minus total current liabilities.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years.
In BlackRock’s case, the retained earnings have averaged $23,241,500,000.00 over the last 4 years, and have been positive since at least 2007. Retained earnings refer to the net income left for equity investors after all expenses have been accounted for, including dividends. It's a similar metric to free cash flow, with the difference being that earnings are calculated on an accrual, as opposed to a cash basis. In other words, earnings don't represent actual cash -- only evidence that the company can or will receive income based on its sales.
There Should Be a Record of Uninterrupted Dividend Payments Over the Last 20 Years.
BlackRock has offered a dividend since at least 2004, and the company has returned an average dividend yield of 2,38% over the last five years.
The Company Should Have a Minimum Increase of at Least One-third in Eps Over the Past 10 Years.
To determine the company's Eps growth over time, we will average out its Eps for 2007, 2008, and 2009, which were $7.37, $5.78, and $6.11 respectively. This gives us an average of $6.00 for the period of 2007 to 2009. Next, we compare this value with the average Eps reported in 2019, 2020, and 2021, which were $28.43, $31.85, and $38.22, for an average of $33.00. Now we can see that the company's Eps growth was 450% during this 13-year period, which satisfies Ben Graham's requirement.
Based on the above analysis, we can conclude that BlackRock satisfies some of the criteria Benjamin Graham used for identifying an undervalued stock because even though it is trading far above its fair value, since it has:
- impressive sales revenue
- an average current ratio
- healthy debt levels
- good record of retained earnings
- a solid record of dividends
- increasing earnings per share
Remember that the above analysis is intended to ensure that investors are not overpaying for a stock — but it does not guarantee the stock's price will move upwards!