Many investors turn to Benjamin Graham's so-called “Graham number” to calculate the fair price of a stock. The Graham number is √(22.5 * earnings per share * book value per share), which for Macy's gives us a fair price of $37.01. In comparison, the stock’s market price is $20.65 per share. Macy's’s current market price is -44.2% below its Graham number, which implies that there is upside potential -- even for a conservative investors who require a significant margin of safety.
The Graham number is often used in isolation, but 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 analysis also touches on the following points:
Sales Revenue Should Be No Less Than $100 million.
For Macy's, average sales revenue over the last few years has been $23,614,750,000.00, so according to the analysis the stock has impressive sales revenue.
Current Assets Should Be at Least Twice Current Liabilities.
We calculate Macy's's current ratio by dividing its total current assets of $6,758,000,000 by its total current liabilities of $5,416,000,000. 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. Macy's’s current assets outweigh its current liabilities by a factor of 1.2 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 Macy's’s debt ratio is 2.5, the company has too much debt. We calculate Macy's’s debt to net current assets ratio by dividing its total long term of debt of $3,295,000,000 by its current assets minus total current liabilities.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years.
In Macy's’s case, the retained earnings have averaged $6,308,750,000 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.
There Should Be a Record of Uninterrupted Dividend Payments Over the Last 20 Years.
Macy's has offered regular dividends since at least 2003, and has returned a 3.0% dividend yield over the last 12 months.
The Company Should Have a Minimum Increase of at Least One-third in Eps Over the Past 10 Years.
Macy's's earnings per share growth will be calculated using the average EPS of the years 2008, 2009, and 2010, and the average of the years 2020, 2021, and 2022. For the years starting in 2008, we have Eps values of $1.97, $-11.34, and $0.78, which give us an average of $-2.86. From 2020 to the present, we have EPS values of $1.81, $-12.68, and $4.55, which average out to $-2.11. The growth rate between the two averages is 26.22%, which falls short of Graham's 30% requirement while remaining positive.
Based on the above analysis, we can conclude that Macy's satisfies some of the criteria Benjamin Graham used for identifying for an undervalued stock because it is trading far below its fair value and has:
- impressive sales revenue
- an average current ratio
- too much debt
- good record of retained earnings
- a decent dividend record
- growing earnings per share