Toll Brothers is currently trading at $71.33 per share and has a Graham number of $111.89, which implies that it is -36.2% below its fair value. We calculate the Graham number as follows:
√(22.5 * 5 year average earnings per share * book value per share) = √(22.5 * 5.49 * 61.948) = 111.89
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 Toll Brothers, average sales revenue over the last 6 years has been $10.38 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 Toll Brothers's current ratio by dividing its total current assets of $11.15 Billion by its total current liabilities of $4.27 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. In Toll Brothers’s case, current assets outweigh current liabilities by a factor of 2.6.
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 Toll Brothers’s debt ratio is 0.4, the company has too much debt. We calculate Toll Brothers’s debt to net current assets ratio by dividing its total long term of debt of $2.0 Billion by its current assets minus total liabilities of $6.27 Billion.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
Toll Brothers had positive retained earnings from 2009 to 2022 with an average of $3.84 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 Toll Brothers have received regular dividends since 2017. The company has returned an average dividend yield of 1.2% 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 Toll Brothers's EPS growth over time, we will average out its EPS for 2008, 2009, and 2010, which were $-1.88, $-4.68, and $-0.02 respectively. This gives us an average of $-2.19 for the period of 2008 to 2010. Next, we compare this value with the average EPS reported in 2020, 2021, and 2022, which were $1.55, $6.63, and $5.63, for an average of $4.60. Now we see that Toll Brothers's EPS growth was 310.05% during this period, which satisfies Ben Graham's requirement.
Based on the above analysis, we can conclude that Toll Brothers meets most of Benjamin Graham's criteria for an undervalued stock because it is trading far below its fair value and has:
- impressive sales revenue
- an excellent current ratio
- too much debt
- positive retained earnings from 2009 to 2022
- an acceptable record of dividends
- EPS growth in excess of Graham's requirements
