How to Evaluate a Stock?

Navigating the stock market in today’s volatile environment requires a clear strategy to separate the winners from the overpriced traps. With markets facing uncertainty—from economic slowdowns to global tensions—knowing how to evaluate a stock’s true value is more important than ever. At Vorpp Capital, we’ve been exploring various trading and investing approaches, from swing trading to understanding market cycles, and one timeless method stands out for its simplicity and effectiveness: the Graham Number. Developed by Benjamin Graham, the legendary investor and mentor to Warren Buffett, this formula offers a straightforward way to assess a stock’s fair value. In this article, we’ll dive into how to evaluate a stock using the Graham Number, explain how to calculate it, and show you how to find key metrics like P/E and P/B ratios using TradingView’s stock screener. By combining this fair value analysis with a solid chart setup, you can boost your returns, avoid chasing expensive stocks, and gain a clearer sense of what “expensive” really looks like. Let’s break it down and get you equipped to make smarter investment decisions.

The Importance of Evaluating a Stock’s Value

Before diving into the mechanics, let’s talk about why evaluating a stock’s value matters. The stock market is a place of endless noise—headlines, hype, and herd behavior can drive prices far from their true worth. Buying a stock without understanding its value is like buying a car without checking its condition—you might overpay and regret it later. A proper valuation helps you determine if a stock is undervalued (a potential bargain) or overvalued (a risk to avoid), ensuring you invest with a margin of safety. This approach aligns with the principles of value investing, which prioritize buying quality companies at a price below their intrinsic worth, setting you up for better returns over time.

In volatile markets, where corrections and unexpected swings are common, chasing stocks at inflated prices can lead to significant losses. Conversely, identifying undervalued stocks with strong fundamentals and a favorable chart setup can position you to capture gains when the market recognizes their true value. The Graham Number, developed by Benjamin Graham—often called the “father of value investing”—is a powerful tool to help you do just that. It’s a method rooted in fundamentals, focusing on a company’s earnings and book value to estimate a fair price, and when paired with technical analysis, it can guide you toward smarter trades and investments.

Understanding the Graham Number: A Value Investor’s Tool

The Graham Number is a valuation metric created by Benjamin Graham to help investors identify stocks that are undervalued based on their fundamental financials. Graham, whose teachings influenced investing giants like Warren Buffett, outlined this approach in his seminal book, The Intelligent Investor. The Graham Number provides a quick estimate of a stock’s fair value—what Graham called the “upper bound” a defensive investor should pay—by focusing on two key metrics: earnings per share (EPS) and book value per share (BVPS). It’s a simple yet effective way to gauge whether a stock is trading at a price that offers a margin of safety, a core principle of value investing.

The formula for the Graham Number is straightforward:

Graham Number = Square Root of (22.5 × Earnings Per Share × Book Value Per Share)

Let’s break down each component:

• Earnings Per Share (EPS): This measures a company’s net profit divided by its number of outstanding shares, reflecting its profitability on a per-share basis. It gives you a sense of how much the company earns for each share of stock, a key indicator of financial health.
• Book Value Per Share (BVPS): This represents the company’s equity available to common shareholders divided by its outstanding shares, essentially the net asset value per share. It indicates the underlying value of the company if it were liquidated, providing a baseline for its worth.
• The 22.5 Factor: This number is derived from Graham’s criteria for a defensive investment—a maximum price-to-earnings (P/E) ratio of 15 and a maximum price-to-book (P/B) ratio of 1.5, multiplied together (15 × 1.5 = 22.5). Graham believed these limits ensured a stock wasn’t overpriced relative to its earnings and assets.

The Graham Number represents the maximum price a value investor should consider paying for a stock. If the current market price is below this number, the stock may be undervalued and worth investigating further; if it’s above, the stock might be overvalued, signaling caution. This method is particularly suited for stable companies with positive earnings and tangible assets, as it doesn’t account for high-growth or asset-light firms.

How to Calculate the Graham Number: A Step-by-Step Guide

Calculating the Graham Number is a straightforward process once you have the necessary data. Let’s walk through the steps to evaluate a hypothetical stock, which we’ll call Company XYZ, to illustrate how it works.

First, you need to gather the two key inputs: EPS and BVPS. These can typically be found on financial websites, company earnings reports, or through a stock screener like TradingView, which we’ll explore later. For Company XYZ, let’s assume the following:

• The company’s net profit over the past year is $50 million, and it has 10 million outstanding shares. This gives an EPS of $50 million divided by 10 million, or $5 per share.
• The company’s shareholders’ equity is $150 million, with the same 10 million shares outstanding. This results in a BVPS of $150 million divided by 10 million, or $15 per share.

Next, plug these values into the Graham Number formula:

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

For Company XYZ:

• Multiply 22.5 by the EPS of $5, which equals 112.5.
• Multiply 112.5 by the BVPS of $15, which equals 1687.5.
• Take the square root of 1687.5, which is approximately $41.07.

The Graham Number for Company XYZ is $41.07, meaning a defensive investor should consider paying no more than this price to ensure a margin of safety. If Company XYZ’s current market price is $30, it might be undervalued—a potential buy. If it’s trading at $50, it could be overvalued, suggesting caution.

This calculation is a starting point, not a definitive answer. Graham intended it as a tool for defensive investors seeking stable, undervalued stocks, and it works best when combined with other analyses, such as a company’s management quality, industry trends, and market conditions.

Finding P/E, P/B, and More with TradingView’s Stock Screener

To calculate the Graham Number, you need reliable data for EPS and BVPS, and you’ll also want to check other metrics like P/E and P/B ratios to contextualize a stock’s valuation. TradingView offers a powerful stock screener that makes this process seamless, allowing you to filter stocks based on fundamental and technical criteria. Here’s how to use it to gather the data you need and identify potential investment opportunities.

Start by accessing TradingView’s stock screener, which is available on their platform under the “Screener” tab. Once there, select “Stocks” to focus on equities, and you’ll see a range of filters to customize your search. To find stocks that align with Graham’s criteria, focus on the fundamental filters:

• Earnings Per Share (EPS): Under the “Fundamentals” section, look for “EPS (TTM)” (trailing twelve months). This gives you the company’s earnings per share over the past year, a key input for the Graham Number.
• Book Value Per Share (BVPS): Also in the fundamentals section, find “Book Value Per Share.” This reflects the company’s net asset value per share, the second input for the Graham Number.
• Price-to-Earnings (P/E) Ratio: Filter for “P/E Ratio (TTM)” to see how the stock’s current price compares to its earnings. Graham recommended a P/E ratio below 15 for defensive investments, so you can set this as a maximum threshold.
• Price-to-Book (P/B) Ratio: Look for “P/B Ratio” to compare the stock’s price to its book value. Graham suggested a P/B ratio below 1.5, another useful filter to apply.

Let’s set up a basic screen to find potential candidates. Start by filtering for companies with positive EPS and BVPS, as the Graham Number formula requires both to be positive. Next, add filters for a P/E ratio below 15 and a P/B ratio below 1.5, aligning with Graham’s defensive criteria. You can also narrow your search by market capitalization, industry, or dividend yield if you prefer stable, dividend-paying stocks. Once you apply these filters, TradingView will generate a list of stocks meeting your criteria, complete with their EPS, BVPS, P/E, and P/B ratios.

For each stock on the list, calculate its Graham Number using the formula above. Compare the result to the stock’s current market price—stocks trading below their Graham Number may be undervalued, making them candidates for further research. TradingView also lets you sort results by these metrics, helping you quickly identify stocks that align with Graham’s value principles.

Combining Fair Value with Chart Setups for Better Returns

While the Graham Number helps you identify undervalued stocks, pairing this fair value analysis with a proper chart setup can significantly boost your returns. Valuation tells you what to buy; technical analysis tells you when to buy it. By combining these approaches, you avoid chasing expensive stocks and position yourself to enter at optimal points, maximizing your profit potential while minimizing risk.

Let’s say you’ve identified Company XYZ as undervalued—its Graham Number is $41.07, but it’s trading at $30. Now, head to TradingView’s charting tools to analyze its price action. Look for a bullish chart setup that signals a potential upward move, confirming your value-based hypothesis. For example, you might find the stock has recently bounced off a strong support level—a price where it has historically reversed upward—showing increased buying interest. Alternatively, you could look for a breakout above a resistance level, indicating momentum, or a bullish pattern like a double bottom, suggesting a trend reversal.

The key is to align your entry with both value and momentum. If Company XYZ is undervalued but its chart shows a downtrend with no signs of reversal, you might wait for a better setup to avoid catching a falling knife. Conversely, if the stock is breaking out on strong volume while trading below its Graham Number, you have a high-probability trade—value and technicals are in sync. This approach helps you avoid expensive stocks, which often trade far above their fair value with chart patterns showing overextension, like a steep parabolic rise that’s likely to reverse.

An “expensive” stock, in this context, is one trading significantly above its Graham Number, often with a P/E or P/B ratio well beyond Graham’s thresholds. For instance, a tech stock trading at a P/E of 30 and a P/B of 3 might have a Graham Number far below its current price, signaling overvaluation. On the chart, if it’s showing signs of exhaustion—say, a sharp rally followed by declining volume—it’s likely overbought, making it a risky buy. By focusing on stocks that are both undervalued and technically sound, you position yourself for better returns while steering clear of overhyped traps.

Why This Matters in Volatile Markets

The truth about trading, as we’ve discussed, resonates deeply in turbulent market environments, where uncertainty often reigns supreme. Markets can face corrections driven by a myriad of factors—global tensions, economic slowdowns, or shifts in monetary policy that raise fears of deflation or recession. New traders might be tempted to chase a “perfect” strategy, hoping to predict the next big move—buying a dip in the hopes of a rebound or shorting a rally expecting a crash. However, as we’ve seen with market cycles, periods of complacency frequently give way to panic, and attempting to pinpoint an exact bottom or top is often a futile endeavor.

A disciplined trader, by contrast, thrives in such conditions. They don’t need to know whether a major index will bottom tomorrow—they need a strategy that delivers consistent results over time. They might buy a stock at a well-established support level, risking a small loss for the potential of a larger gain, or use order flow techniques to scalp intraday moves in a trending asset. Their focus is on execution, not prophecy. This approach allows them to navigate market volatility with confidence, knowing their edge will play out over a series of trades, even if the market’s next move remains uncertain.

Final Thoughts: Valuation and Timing for Smarter Investing

At Vorpp Capital, we believe evaluating a stock’s value is a cornerstone of smarter investing, especially in markets prone to volatility and overreaction. The Graham Number, developed by Benjamin Graham, offers a timeless way to estimate a stock’s fair value, helping you identify undervalued opportunities with a margin of safety. By calculating it using a company’s earnings per share and book value per share—data you can easily find with TradingView’s stock screener—you can spot stocks trading below their intrinsic worth, avoiding the trap of overpaying for expensive names. Pairing this fair value analysis with a solid chart setup, like a bullish breakout or support bounce, ensures you time your entries for maximum returns while steering clear of overhyped stocks showing signs of overvaluation.

In a market environment where uncertainty looms—from economic slowdowns to global tensions—this disciplined approach is your edge. Expensive stocks, trading well above their Graham Number with lofty P/E and P/B ratios, often signal risk, especially when their charts show overextension. By focusing on undervalued stocks with favorable technical setups, you position yourself to capture gains while managing risk, aligning with the principles of value investing that have stood the test of time. Whether you’re swing trading or day trading, this combination of valuation and timing can guide you toward better decisions, helping you navigate the market’s ups and downs with confidence.

Do not consider this article as financial advice. We only showcase our own opinion. Always do your own due diligence before investing in alternative (volatile) investment opportunities.