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 * 5 year average earnings per share * book value per share), which for TE Connectivity gives us a fair price of $61.07. In comparison, the stock’s market price is $126.49 per share. Therefore, TE Connectivity’s market price exceeds the upper bound that a prudent investor would pay for its shares by 107.1%.
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 TE Connectivity:
Sales Revenue Should Be No Less Than $500 million
For TE Connectivity, average sales revenue over the last 4 years has been $14,206,000,000, 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 TE Connectivity's current ratio by dividing its total current assets of $7,268,000,000 by its total current liabilities of $4,632,000,000. 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. TE Connectivity’s current assets outweigh its current liabilities by a factor of 1.6 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 TE Connectivity’s debt ratio is -1.3, the company has negative current asset / liability balance. We calculate TE Connectivity’s debt to net current assets ratio by dividing its total long term of debt of $3,292,000,000 by its current assets minus total liabilities of $9,885,000,000.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
TE Connectivity had negative retained earnings in 2009 with an average of $6,034,000,000. 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
Shareholders of TE Connectivity have received regular dividends since 2009. The company has returned an average dividend yield of 1.8% over the last five years.
A Minimum Increase of at Least One-third in Earnings per Share (EPS) Over the Past 10 Years
To determine TE Connectivity's EPS growth over time, we will average out its EPS for 2007, 2008, and 2009, which were $-1.11, $-0.08, and $0.37 respectively. This gives us an average of $-0.27 for the period of 2007 to 2009. Next, we compare this value with the average EPS reported in 2020, 2021, and 2022, which were $0.69, $6.79, and $7.47, for an average of $4.98. Now we see that TE Connectivity's EPS growth was 1944.44% during this period, which satisfies Ben Graham's requirement.
It may be trading far above its fair value, but TE Connectivity actually does not have the profile of a defensive stock according to Benjamin Graham's criteria because it has:
- impressive sales revenue
- an average current ratio
- negative current asset / liability balance
- negative retained earnings in 2009
- a solid record of dividends
- EPS growth in excess of Graham's requirements