Screening By P/E and P/B Ratios Simultaneously

Being a combination of the Price-to-Earnings and Price-To-Book ratios, the Graham Number gives more comprehensive insight into a stock than either ratio used alone.

The Ratios

Price-to-Earnings (P/E)

Earnings Per Share (EPS) indicates how much profit the company makes per share.

EPS definition

EPS combined with Price gives an idea of the rate of return one can expect on one's investment. EPS and Price are usually measured together as the P/E ratio, or Price-to-Earnings ratio.

Price-To-Book (P/B)

Book Value Per Share (BVPS) is the theoretical liquidation value of the stock. BVPS indicates how much one would be paid per share if the company were to close tomorrow.

BVPS definition

BVPS combined with Price gives a rough idea of the collateral on one's investment. BVPS and Price are usually measured together as the P/B ratio, or Price-to-Book ratio.

Graham Number

The Value Investing framework of Benjamin Graham — Warren Buffett's mentor — states that a stock for Defensive investment should have:

6. Current price should not be more than 15 times average earnings of the past three years.
7. Current price should not be more than 1½ times the book value last reported.
As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5.
Benjamin Graham, Chapter 14: Stock Selection for the Defensive Investor, The Intelligent Investor.

These two rules together yield what is known today as the Graham Number.

Graham Number = Square Root of (15 x 1.5 x EPS x BVPS)

Graham Number = Square Root of (22.5 x EPS x BVPS)

The Graham Number is designed to assess stocks regardless of sector. Companies from low-earnings industries such as Utilities will need higher asset figures, and those from low-asset ones such as Financial Services will need higher earnings figures.

Note: The Graham Number too is not meant to be used in isolation, despite its higher versatility.

Serenity Number

For more Enterprising (or aggressive) investors, Graham recommended:

"issues selling at multipliers under 10... Price: Less than 120% net tangible assets."
Benjamin Graham, Chapter 15: Stock Selection for the Enterprising Investor, The Intelligent Investor.

These rules yield a similar price calculation, referred to on Serenity as the Serenity Number.

Serenity Number = Square Root of (10 x 1.2 x EPS x TBVPS)

Serenity Number = Square Root of (12 x EPS x TBVPS)

Graham Number(%)

Graham Number(%) is Graham Number ÷ Previous Close.

So a stock with a Graham Number(%) of 200% will have a P/E value of 7.5 and a P/B value of 0.75 — or a higher value in one corresponding to a lower value in the other — yielding a total multiple of 5.625 (22.5 ÷ 2²).

Graham Number(%) is thus a combination of the Price-to-Earnings and the Price-To-Book ratios, and yields better results than either ratio used on its own.

Intrinsic Value(%)

Similarly, Intrinsic Value(%) is Intrinsic Value ÷ Previous Close.

Intrinsic Value(%) = Intrinsic Value ÷ Previous Close

The Intrinsic Value of an Enterprising grade stock is its Serenity Number.

An Enterprising grade stock with an Intrinsic Value(%) of 200% will have a P/E value of 5 and a P/B (tangible) value of 0.6 — or a higher value in one corresponding to a lower value in the other — yielding a total multiple of 3 (12 ÷ 2²).

Screening

The below screener links will display stocks with Graham Number(%) higher than 200% and Serenity Number(%) higher than 200% respectively.

Graham Resources