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 Microsoft gives us a fair price of $58.61601956803276. In comparison, the stock’s market price is $258.06 per share. Therefore, Microsoft’s market price exceeds the upper bound that a prudent investor would pay for its shares by 340.2550734453784%.
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 requires us to look at the following fundamentals of Microsoft:
Sales Revenue Should Be No Less Than $500 million
For Microsoft, average sales revenue over the last 5 years has been $146,653,000,000, so in the context of the Graham analysis the stock has impressive sales revenue. Originally the threshold was $100 million, but since the book was published in the 1970s it's necessary to adjust the figure for inflation.
Current Assets Should Be at Least Twice Current Liabilities
We calculate Microsoft's current ratio by dividing its total current assets of $169,684,000,000 by its total current liabilities of $95,082,000,000. 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. Microsoft’s current assets outweigh its current liabilities by a factor of 1.7846069708251824 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 Microsoft’s debt ratio is None, the company has lacking information on debt levels. We calculate Microsoft’s debt to net current assets ratio by dividing its total long term of debt of $49,781,000,000 by its current assets minus total current liabilities.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
Microsoft had negative retained earnings in 2009 and 2010, during which time they averaged $17,701,923,077. 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
Microsoft has offered a regular dividend since at least 2008. The company has returned an average dividend yield of % over the last five years.
A Minimum Increase of at Least One-third in Earnings per Share (EPS) Over the Past 10 Years
Microsoft does not have the profile of a defensive stock according to Benjamin Graham's criteria because in addition to trading far above its fair value, it has:
- impressive sales revenue
- an average current ratio
- lacking information on debt levels
- negative retained earnings in 2009 and 2010
- a solid record of dividends
- inadequate information on EPS growth