Microsoft is currently trading at $311.4 per share and has a Graham number of $69.25, which implies that it is 349.7% above its fair value. We calculate the Graham number as follows:
√(22.5 * 5 year average earnings per share * book value per share) = √(22.5 * 5.65 * 27.748) = 69.25
The Graham number is one of seven factors that Graham enumerates in Chapter 14 of The Intelligent Investor for determining whether a stock offers a margin of safety. Rather than use the Graham number by itself, its best to consider it alongside the following fundamental metrics:
Sales Revenue Should Be No Less Than $500 million
For Microsoft, average sales revenue over the last 6 years has been $198.59 Billion, 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 $169.68 Billion by its total current liabilities of $95.08 Billion. 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 1.8 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 -1.6, the company has much more liabilities than current assets. We calculate Microsoft’s debt to net current assets ratio by dividing its total long term of debt of $47.03 Billion by its current assets minus total liabilities of $198.3 Billion.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
Microsoft had negative retained earnings in 2009 and 2010 with an average of $24.93 Billion. 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 Microsoft have received regular dividends since 2008. The company has returned an average dividend yield of 1.1% 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 Microsoft's EPS growth over time, we will average out its EPS for 2007, 2008, and 2009, which were $0.50, $0.47, and $0.74 respectively. This gives us an average of $0.57 for the period of 2007 to 2009. Next, we compare this value with the average EPS reported in 2021, 2022, and 2023, which were $8.05, $9.65, and $9.68, for an average of $9.13. Now we see that Microsoft's EPS growth was 1501.75% during this period, which satisfies Ben Graham's requirement.
It may be trading far above its fair value, but Microsoft actually does not have the profile of a defensive stock according to Benjamin Graham's criteria because it has:
- impressive sales revenue
- a decent current ratio
- much more liabilities than current assets
- negative retained earnings in 2009 and 2010
- a solid record of dividends
- EPS growth in excess of Graham's requirements