Many investors turn to Benjamin Graham's so-called “Graham number” to calculate the fair price of a stock. But the Graham number shouldn't be used in isolation. In fact it is only one part of a check list for choosing defensive stocks that he laid out in Chapter 14 of The Intelligent Investor.
The Graham number is the square root of (22.5 x earnings per share x book value per share), which for Cisco Systems gives us a fair price of $24.73. In comparison, the stock’s market price is $49.17 per share. Therefore, Cisco Systems’s market price exceeds the upper bound that a prudent investor would pay for its shares by 98.8%. And now for the rest of the checklist:
Sales Revenue Should Be No Less Than $100 million.
For Cisco Systems, average sales revenue over the last few years has been $50,645,000,000.00, so according to the analysis the stock has impressive sales revenue.
Current Assets Should Be at Least Twice Current Liabilities.
We calculate Cisco Systems's current ratio by dividing its total current assets of $36,717,000,000.00 by its total current liabilities of $25,640,000,000.00. 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. Cisco Systems’s current assets outweigh its current liabilities by a factor of 1.4 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 Cisco Systems’s debt ratio is 0.8, the company has healthy debt levels. We calculate Cisco Systems’s debt to net current assets ratio by dividing its total long term of debt of $8,416,000,000.00 by its current assets minus total current liabilities.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years.
In Cisco Systems’s case, the retained earnings have averaged $-2,659,750,000.00 over the last 4 years. 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.
Cisco Systems has offered an uninterrupted dividend since at least 2013, and has returned an average dividend yield of 2.92% 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 2009, 2010, and 2011, which were $1.05, $1.33, and $1.17 respectively. This gives us an average of $1.00 for the period of 2009 to 2011. Next, we compare this value with the average Eps reported in 2020, 2021, and 2022, which were $2.64, $2.50, and $2.82, for an average of $3.00. Now we see that the company's Eps growth was 200% during this period, which satisfies Ben Graham's requirement.
Based on the above analysis, we can conclude that Cisco Systems does not have the profile of a defensive stock according to Benjamin Graham's criteria because it is trading far above its fair value and has:
- impressive sales revenue
- an average current ratio
- healthy debt levels
- a poor record of retained earnings
- a solid record of dividends
- growing earnings per share
