Is This Financial Company Cheap According to Graham?

Earlier this year, I spent some time dissecting Benjamin Graham's The Intelligent Investor, the seminal book on value investing. Along the way, I talked about the Graham number as a means of valuation when it comes to stocks. The formula is pretty straightforward: Multiply earnings per share by book value per share, then multiply that by 22.5, and finally take the square root. The result, in dollars, is the Graham number.

However, a quick check can help determine whether or not a company might be worthy of a look using the teachings of Graham. He said that in an ideal situation, the P/E ratio and P/B ratio multiplied together should not exceed 22.5, with a maximum P/E ratio of 15 and P/B of 1.5. With that in mind, I looked at the stocks of the S&P 500 that met the ideal situation mentioned above. Currently, there are 65 companies in the index that meet these criteria. I will be making a CAPScall on these companies after comparing them to competitors and their current value in relation to their Graham numbers. Up next is asset management firm Bank of New York Mellon (NYSE: BK  ) .

Who are they?
Despite having the word "bank" in its name, Bank of New York Mellon operates a little differently than the banks you and I use. It focuses more on custodial services for other financial institutions and not necessarily individual depositors. Because of this -- despite a record low interest rate environment -- it received a vote of confidence from Warren Buffett, with the recent disclosure that Berkshire Hathaway  (NYSE: BRK-B  ) tripled its position in the company during the last quarter. With Treasury Secretary Geithner cracking down on the industry, hopefully we will all avoid another financial collapse like the one in 2008.

What's it worth?
When compared to other financial services companies of similar size, BNY Mellon trails only Capital One Financial (NYSE: COF  ) , which is primarily a credit card company, and Prudential Financial (NYSE: PRU  ) , which gets a boost from its insurance business:

Company

EPS (ttm)

Book Value Per Share (mrq)

Graham Number

Recent Price

Upside

Bank of New York Mellon

$1.85

$28.81

$34.63

$23.38

48.1%

BlackRock (NYSE: BLK  )

$12.50

$142.69

$200.33

$188.69

6.2%

PNC Financial Services (NYSE: PNC  )

$4.84

$64.06

$83.52

$64.49

29.5%

Capital One Financial

$5.34

$64.38

$87.95

$59.05

48.9%

Prudential Financial

$7.15

$81.59

$114.57

$56.67

102.2%

Source: Yahoo! Finance and author's calculations; ttm: trailing 12 months; mrq: most recent quarter.

BlackRock, with nearly $3.5 trillion under management, is the world's largest asset management firm. With an announcement earlier this year that it will be repurchasing $1 billion in shares, the company is attempting to maximize shareholder return. Pittsburgh-based PNC Financial, which owns approximately a quarter of BlackRock, is a diversified financial holding company that provides its customers with a "one-stop" financial stop, though it does seem to take some unnecessary risks in its investments at times.

Despite a fine levied by the CFPB -- or perhaps because of it -- Capital One Financial is currently trading at around half its Graham valuation, making it a slightly cheaper option than BNY Mellon. Finally, Prudential Financial is primarily a seller of life insurance, but this line of business lends itself well to selling other financial products as well, including annuities and other types of insurance. Throw in the room to double to its Graham valuation, and you might just have the best option of the group here.

Accountability time
A stock's valuation, regardless of the method used, is but one thing to look at when evaluating a potential investment. Even though it's not the cheapest here, it still has plenty of room to grow into its Graham number valuation, so I'll be placing a "thumbs up" over on my CAPS page in order to track this call and keep myself accountable. 

Looking for another way to look at smaller banks? In our special report "The Stocks Only the Smartest Investors Are Buying," you can learn why Warren Buffett is interested in bank stocks and learn a little about how he values them. Click here for your free copy before it's too late!

Robert Eberhard owns shares of Berkshire Hathaway. Follow him on Twitter, or click here to see his holdings and a short bio. The Motley Fool owns shares of Berkshire Hathaway and PNC Financial Services. Motley Fool newsletter services recommend Berkshire Hathaway and BlackRock. Try any of our Foolish newsletter services free for 30 days.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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