Investing 101: Highly Profitable Stocks Undervalued by the Graham Number

One helpful way to find potentially undervalued opportunities is from the "godfather of value investing" himself, Benjamin Graham.

Graham created an equation to calculate the maximum fair value for a stock, referred to as the Graham Number. Any stock trading at a significant discount to this number would appear undervalued.

For this list we focus on S&P 500 companies.

We used the Graham Number to screen for potentially undervalued stocks among a universe of S&P 500 stocks that beat the industry average in all of the following ratios:

  • Gross margin
  • Operating margin
  • Pre-tax margin

Want a closer look at these terms and why they're valuable tools in investing? No problem! Let's review:

Market capitalization (market cap): Market capitalization, commonly referred to as market cap, is the total market value of a company's outstanding shares. It can be thought of as a measure of company's size. It can be calculated by multiplying the number of shares by the current price of the shares.

Graham Number: According to Benjamin Graham, a former mentor of Warren Buffett and the so-called "Godfather" of value investing, the Graham Number is the maximum price that a value investor should pay for a given stock. A stock whose share price is below the Graham Number is considered to be undervalued or of good value.

It is a calculation for the fair-value price of a stock based on its earnings per share (EPS) and most recent quarter's book value per share (the value of the company's assets divided by the number of shares).

The Graham Number = Square Root of (22.5) x (TTM EPS) x (MRQ Book Value per Share).

We use trailing 12 month (TTM) diluted EPS. Trailing 12 months (TTM) is an indication that the calculated data has come from the last 12 months.

TTM gross margin: This metric that tells us the percentage of a company's revenue is left after paying all production expenses. Costs include overhead, payroll, and taxation. ((revenues-cost of goods sold) / Revenue) *100 = Gross margin %

TTM

Operating margin: This tells us the percentage remaining after all operating expenses are paid. Operating expenses include: supplies, repairs, research and development, and depreciation. (Operating Income / Net Operating Revenue) *100 = Operating Margin %

TTM

Pre-tax margin: A company's earnings before taxes. This incorporates all of the expenses associated with business excluding taxes. It can help to determine the overall operating efficiency of the firm. The higher the pre-tax margin, the more profitable the company. (Net profit before taxes / net sales) *100 = Pre-tax Margin

Now that you're armed with information, take a look at our profitable stocks below. Do you think their current prices are truly undervalued, as suggested by Graham? Use the list as a starting-off point for your own analysis.

List sorted by potential upside. (Click here to access free, interactive tools to analyze these ideas.)

1. Wells Fargo (NYSE: WFC  ) : Money Center Banks Industry. Market cap of $121.28B. TTM diluted EPS at $2.58, MRQ book value per share at $23.86, implies a Graham number of $37.22 (vs. current price at $24.22, implies a potential upside of 53.66%). TTM gross margin at 80.18% vs. industry gross margin at 71.05. TTM operating margin at 41.61% vs. industry operating margin at 38.92%. TTM pre-tax margin at 24.08% vs. industry pre-tax margin at 22%. It's been a rough couple of days for the stock, losing 17.55% over the last week.

2. Duke Energy (NYSE: DUK  ) : Electric Utilities Industry. Market cap of $22.99B. TTM diluted EPS at $1.54, MRQ book value per share at $17.04, implies a Graham number of $24.3 (vs. current price at $17.31, implies a potential upside of 40.37%). TTM gross margin at 31.76% vs. industry gross margin at 27.1. TTM operating margin at 22.53% vs. industry operating margin at 19.02%. TTM pre-tax margin at 20.7% vs. industry pre-tax margin at 14.92%. It's been a rough couple of days for the stock, losing 7.65% over the last week.

3. M&T Bank (NYSE: MTB  ) : Regional Banks Industry. Market cap of $9.11B. TTM diluted EPS at $7.11, MRQ book value per share at $66.73, implies a Graham number of $103.32 (vs. current price at $74.58, implies a potential upside of 38.54%). TTM gross margin at 81.58% vs. industry gross margin at 71.09. TTM operating margin at 46.94% vs. industry operating margin at 38.97%. TTM pre-tax margin at 33.55% vs. industry pre-tax margin at 22.04%. It's been a rough couple of days for the stock, losing 17.07% over the last week.

4. Public Service Enterprise Group (NYSE: PEG  ) : Diversified Utilities Industry. Market cap of $14.59B. TTM diluted EPS at $3.35, MRQ book value per share at $19.98, implies a Graham number of $38.81 (vs. current price at $29.01, implies a potential upside of 33.77%). TTM gross margin at 34.34% vs. industry gross margin at 26.73. TTM operating margin at 26% vs. industry operating margin at 17.95%. TTM pre-tax margin at 23.53% vs. industry pre-tax margin at 13.16%. It's been a rough couple of days for the stock, losing 11.7% over the last week.

5. Sealed Air (NYSE: SEE  ) : Packaging & Containers Industry. Market cap of $2.88B. TTM diluted EPS at $1.42, MRQ book value per share at $16.19, implies a Graham number of $22.74 (vs. current price at $18.26, implies a potential upside of 24.55%). TTM gross margin at 29.76% vs. industry gross margin at 23.12. TTM operating margin at 11.88% vs. industry operating margin at 10.4%. TTM pre-tax margin at 7.16% vs. industry pre-tax margin at 6.74%. It's been a rough couple of days for the stock, losing 15.84% over the last week.

6. Pinnacle West Capital (NYSE: PNW  ) : Electric Utilities Industry. Market cap of $4.14B. TTM diluted EPS at $2.85, MRQ book value per share at $33.12, implies a Graham number of $46.08 (vs. current price at $38.38, implies a potential upside of 20.08%). TTM gross margin at 34.23% vs. industry gross margin at 27.1. TTM operating margin at 21.27% vs. industry operating margin at 19.02%. TTM pre-tax margin at 15.02% vs. industry pre-tax margin at 14.92%. It's been a rough couple of days for the stock, losing 9.89% over the last week.

7. PPL (NYSE: PPL  ) : Electric Utilities Industry. Market cap of $14.62B. TTM diluted EPS at $2.37, MRQ book value per share at $17.6, implies a Graham number of $30.64 (vs. current price at $25.64, implies a potential upside of 19.48%). TTM gross margin at 36.08% vs. industry gross margin at 27.23. TTM operating margin at 28.11% vs. industry operating margin at 19.1%. TTM pre-tax margin at 17.96% vs. industry pre-tax margin at 14.97%. It's been a rough couple of days for the stock, losing 9.6% over the last week.

8. American Electric Power (NYSE: AEP  ) : Electric Utilities Industry. Market cap of $16.35B. TTM diluted EPS at $2.54, MRQ book value per share at $28.59, implies a Graham number of $40.42 (vs. current price at $33.97, implies a potential upside of 18.99%). TTM gross margin at 32.3% vs. industry gross margin at 27.23. TTM operating margin at 21.24% vs. industry operating margin at 19.1%. TTM pre-tax margin at 15.27% vs. industry pre-tax margin at 14.97%. It's been a rough couple of days for the stock, losing 10.41% over the last week.

9. Unitedhealth Group, (NYSE: UNH  ) : Health Care Plans Industry. Market cap of $45.12B. TTM diluted EPS at $4.46, MRQ book value per share at $25.6, implies a Graham number of $50.68 (vs. current price at $44.13, implies a potential upside of 14.85%). TTM gross margin at 24.76% vs. industry gross margin at 21.03. TTM operating margin at 8.61% vs. industry operating margin at 8.49%. TTM pre-tax margin at 7.92% vs. industry pre-tax margin at 6.88%. It's been a rough couple of days for the stock, losing 12.68% over the last week.

10. People's United Financial (Nasdaq: PBCT  ) : Savings & Loans Industry. Market cap of $3.85B. TTM diluted EPS at $0.47, MRQ book value per share at $15.01, implies a Graham number of $12.6 (vs. current price at $11.01, implies a potential upside of 14.43%). TTM gross margin at 84.79% vs. industry gross margin at 59.91. TTM operating margin at 38.08% vs. industry operating margin at 32.34%. TTM pre-tax margin at 19.23% vs. industry pre-tax margin at 12.98%. It's been a rough couple of days for the stock, losing 13.85% over the last week.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.


Kapitall's Becca Lipman does not own any of the shares mentioned above.

The Motley Fool owns shares of UnitedHealth Group. The Fool owns shares of and has created a ratio put spread position on Wells Fargo. Motley Fool newsletter services have recommended buying shares of UnitedHealth Group. Motley Fool newsletter services have recommended creating a diagonal call position in UnitedHealth Group. 

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