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 Alphabet gives us a fair price of $53.73. In comparison, the stock’s market price is $167.48 per share. Alphabet’s current market price is 211.7% 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 Alphabet:
Sales Revenue Should Be No Less Than $500 million
For Alphabet, average sales revenue over the last 5 years has been $334.24 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 Alphabet's current ratio by dividing its total current assets of $171.53 Billion by its total current liabilities of $81.81 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 Alphabet’s case, current assets outweigh current liabilities by a factor of 2.1.
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 Alphabet’s debt ratio is 0.2, the company has healthy debt levels with a debt to net current asset of 0.2. We calculate Alphabet’s debt to net current assets ratio by dividing its total long term of debt of $13.25 Billion by its current assets minus total liabilities of $119.01 Billion.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
Alphabet had good record of retained earnings with an average of $143.14 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
Alphabet has offered a regular dividend since at least 2024. The company has returned a 0.2% 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
We are going to compare Alphabet's earnings per share averages from the two 'bookends' of the 10 year period for which we have data. The first bookend comprises the years 2013, 2014, and 2016, whose EPS values of $18.79, $20.57, and $27.85 average out to $22.40. Next we look at the years 2021, 2022, and 2023, whose values of $5.61, $4.56, and $5.80 average out to $5.32. The growth rate between the two averages does not meet Graham's standard since it is -76.25%.
Based on the above analysis, we can conclude that Alphabet meets most of Benjamin Graham's criteria for an undervalued stock because it is trading above its fair value and has:
- impressive sales revenue
- an excellent current ratio of 2.1
- healthy debt levels with a debt to net current asset of 0.2
- good record of retained earnings
- a decent record of dividends, with a yield of 0.2% over the last year
- a strong EPS growth trend
