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 Southern Company gives us a fair price of $49.28. In comparison, the stock’s market price is $62.54 per share. Therefore, Southern Company’s market price exceeds the upper bound that a prudent investor would pay for its shares by 26.9%.
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 Southern Company:
Sales Revenue Should Be No Less Than $500 million
For Southern Company, average sales revenue over the last 6 years has been $35.61 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 Southern Company's current ratio by dividing its total current assets of $10.42 Billion by its total current liabilities of $15.72 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. Southern Company’s current liabilities are actually greater than its current assets, since its current ratio is only 0.7.
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 Southern Company’s debt ratio is -0.6, the company has much more liabilities than current assets. We calculate Southern Company’s debt to net current assets ratio by dividing its total long term of debt of $50.66 Billion by its current assets minus total liabilities of $100.36 Billion.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
Southern Company had positive retained earnings from 2008 to 2022 with an average of $9.61 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 Southern Company have received regular dividends since 2007. The company has returned an average dividend yield of 4.2% over the last five years.
A Minimum Increase of at Least One-third in Earnings per Share (EPS) Over the Past 10 Years
Southern Company's earnings per share growth will be calculated using the average EPS of the years 2007, 2008, and 2009, and the average of the years 2020, 2021, and 2022. For the years starting in 2007, we have EPS values of $2.28, $2.25, and $2.06, which give us an average of $2.20. From 2020 to the present, we have EPS values of $2.93, $2.24, and $3.26, which average out to $2.81. The growth rate between the two averages is 27.73%, which falls short of Graham's 30% requirement while remaining positive.
It may be trading far above its fair value, but Southern Company actually satisfies some of the criteria Benjamin Graham used for identifying for an undervalued stock because it has:
- impressive sales revenue
- not enough current assets to cover current liabilities
- much more liabilities than current assets
- positive retained earnings from 2008 to 2022
- a solid record of dividends
- some EPS growth
