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 D.R. Horton gives us a fair price of $83.76. In comparison, the stock’s market price is $89.14 per share. Therefore, D.R. Horton’s market price somewhat exceeds the upper bound that a prudent investor would pay for its shares by 6.4%.
The Graham number is often used in isolation, but in fact it is only one part of a check list for choosing defensive stocks according to the fundamentals 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 $500 million
For D.R. Horton, average sales revenue over the last four years has been $24,789,550,000, so according to the analysis the stock has impressive sales revenue.
Current Assets Should Be at Least Twice Current Liabilities
We calculate D.R. Horton's current ratio by dividing its total current assets of $28,800,800,000 by its total current liabilities of $2,647,200,000. 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. In D.R. Horton’s case, current assets outweigh current liabilities by a factor of 10.9.
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 D.R. Horton’s debt ratio is 0.2, the company has healthy debt levels. We calculate D.R. Horton’s debt to net current assets ratio by dividing its total long term of debt of $6,066,900,000 by its current assets minus total current liabilities.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
D.R. Horton had positive retained earnings from 2009 to 2022, during which time they averaged 12,556,875,000. Retained earnings are the sum of the current and previous reporting periods' net asset amounts, minus all dividend payments. It's a similar metric to free cash flow, with the difference that retained earnings are accounted for on an accrual basis.
There Should Be a Record of Uninterrupted Dividend Payments Over the Last 20 Years
D.R. Horton has offered a regular dividend since at least 2008. The company has returned an average dividend yield of 1.1% 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 D.R. Horton's EPS growth over time, we will average out its EPS for 2008, 2009, and 2010, which were $-8.34, $0.56, and $-0.06 respectively. This gives us an average of $-2.61 for the period of 2008 to 2010. Next, we compare this value with the average EPS reported in 2020, 2021, and 2022, which were $2.24, $11.41, and $16.51, for an average of $10.05. Now we see that D.R. Horton's EPS growth was 485.06% during this period, which satisfies Ben Graham's requirement.
In addition to trading around its fair value, D.R. Horton meets most of Benjamin Graham's criteria for an undervalued stock because it has:
- impressive sales revenue
- an excellent current ratio
- healthy debt levels
- positive retained earnings from 2009 to 2022
- a solid record of dividends
- EPS growth in excess of Graham's requirements