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 Builders FirstSource gives us a fair price of $99.28. In comparison, the stock’s market price is $181.04 per share. Builders FirstSource’s current market price is 82.4% above its Graham number, which implies that there is upside potential -- even for a conservative investors who require a significant margin of safety.
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 Builders FirstSource:
Sales Revenue Should Be No Less Than $500 million
For Builders FirstSource, average sales revenue over the last 5 years has been $20.37 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 Builders FirstSource's current ratio by dividing its total current assets of $3.3 Billion by its total current liabilities of $1.86 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. Builders FirstSource’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 Builders FirstSource’s debt ratio is -1.3, the company has much more liabilities than current assets because its long term debt to net current asset ratio is -1.3. We calculate Builders FirstSource’s debt to net current assets ratio by dividing its total long term of debt of $3.18 Billion by its current assets minus total liabilities of $5.77 Billion.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
Builders FirstSource had good record of retained earnings with an average of $23.21 Million. 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
We have no record of Builders FirstSource offering a regular dividend within the last twenty years.
A Minimum Increase of at Least One-third in Earnings per Share (EPS) Over the Past 10 Years
To determine Builders FirstSource's EPS growth over time, we will average out its EPS for 2012, 2013, and 2014, which were $-0.60, $0.05, and $0.18 respectively. This gives us an average of $-0.12 for the period of 2012 to 2014. Next, we compare this value with the average EPS reported in 2021, 2022, and 2023, which were $8.48, $16.82, and $11.94, for an average of $12.41. Now we see that Builders FirstSource's EPS growth was 10441.67% during this period, which satisfies Ben Graham's requirement.
Based on the above analysis, we can conclude that Builders FirstSource meets most of Benjamin Graham's criteria for an undervalued stock because it is trading above its fair value and has:
- impressive sales revenue
- a decent current ratio of 1.77
- much more liabilities than current assets because its long term debt to net current asset ratio is -1.3
- good record of retained earnings
- no dividend record from EDGAR
- exceptional EPS growth
