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 Carrier Global gives us a fair price of $19.37. In comparison, the stock’s market price is $72.78 per share. Carrier Global’s current market price is 275.7% 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 Carrier Global:
Sales Revenue Should Be No Less Than $500 million
For Carrier Global, average sales revenue over the last 5 years has been $23.62 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 Carrier Global's current ratio by dividing its total current assets of $18.78 Billion by its total current liabilities of $6.89 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 Carrier Global’s case, current assets outweigh current liabilities by a factor of 2.7.
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 Carrier Global’s debt ratio is -2.8, the company has much more liabilities than current assets because its long term debt to net current asset ratio is -2.8. We calculate Carrier Global’s debt to net current assets ratio by dividing its total long term of debt of $14.24 Billion by its current assets minus total liabilities of $23.82 Billion.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
Carrier Global had good record of retained earnings with an average of $3.39 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 Carrier Global have received regular dividends since 2020. The company has returned a 1.1% dividend yield over the last 12 months.
A Minimum Increase of at Least One-third in Earnings per Share (EPS) Over the Past 10 Years
There are only 6 years of EPS data available on Carrier Global, which is short of the required 10, but it's still worthwhile to consider its EPS trend over the available period. First, we will average out its EPS for 2018 and 2019 which were $3.16 and $0.50 respectively. This gives us an average of $1.83 for the period of 2018 to 2019. Next, we compare this value with the average EPS reported in 2022 and 2023, which were $4.10 and $1.58, for an average of $2.84. Now we see that Carrier Global's EPS growth was 55.19% during this period, which satisfies Ben Graham's requirement for growth.
Based on the above analysis, we can conclude that Carrier Global satisfies some of the criteria Benjamin Graham used for identifying for an undervalued stock because it is trading above its fair value and has:
- impressive sales revenue
- an excellent current ratio of 2.73
- much more liabilities than current assets because its long term debt to net current asset ratio is -2.8
- good record of retained earnings
- an acceptable record of dividends
- declining EPS growth
