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 Ferguson Enterprises gives us a fair price of $73.32. In comparison, the stock’s market price is $196.52 per share. Ferguson Enterprises’s current market price is 168.0% 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 Ferguson Enterprises:
Sales Revenue Should Be No Less Than $500 million
For Ferguson Enterprises, average sales revenue over the last 4 years has been $30.19 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 Ferguson Enterprises's current ratio by dividing its total current assets of $9.47 Billion by its total current liabilities of $5.54 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. Ferguson Enterprises’s current assets outweigh its current liabilities by a factor of 1.7 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 Ferguson Enterprises’s debt ratio is -2.4, the company has much more liabilities than current assets because its long term debt to net current asset ratio is -2.4. We calculate Ferguson Enterprises’s debt to net current assets ratio by dividing its total long term of debt of $3.81 Billion by its current assets minus total liabilities of $11.06 Billion.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
Ferguson Enterprises had good record of retained earnings with an average of $7.4 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
Ferguson Enterprises has offered a regular dividend since at least 2020. The company has returned an average dividend yield of 2.0% over the last five years.
A Minimum Increase of at Least One-third in Earnings per Share (EPS) Over the Past 10 Years
We only have 4 years of EPS on Ferguson, so it fails the Graham test on this basis alone, but we still think it's worthwhile to look at its growth over the available period. In 2020, the earnings per share was $4.24, while in 2023, it was $9.12. This give us a 115.09% growth rate during this period, which will satisfy Ben Graham's requirement if it continues on this trend.
Based on the above analysis, we can conclude that Ferguson Enterprises 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 1.71
- much more liabilities than current assets because its long term debt to net current asset ratio is -2.4
- good record of retained earnings
- an acceptable record of dividends
- a strong EPS growth trend
