Is This Energy 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 leading coal company Peabody Energy (NYSE: BTU  ) .

Who are they?
Peabody Energy is an American coal company, though they recently expanded operations into Australia with the acquisition of some mines. This expansion should help them compete in the growing Asian coal market, although some analyses question whether coal's glory days are in the past. However, my Foolish colleague Chris Barker remains bullish on the mineral, naming Peabody as his top energy stock for 2012.

What's it worth?
Among companies with similar market caps, Peabody has a lot of room to grow to its Graham number valuation, but there are some other interesting options in the sector:

Company

EPS (ttm)

Book Value Per Share (mrq)

Graham Number

Recent Price

Upside

Peabody Energy

$3.22

$21.74

$39.69

$23.93

65.8%

CONSOL Energy (NYSE: CNX  )

$2.67

$17.00

$31.96

$33.11

(3.5%)

Cameco Corporation (NYSE: CCJ  )

$1.15

$12.89

$18.26

$19.30

(5.4%)

Walter Energy (NYSE: WLT  )

$3.61

$35.20

$53.47

$35.74

49.6%

Yanzhou Coal Mining (NYSE: YZC  )

$2.89

$14.21

$30.40

$15.60

94.9%

Source: Yahoo! Finance and author's calculations

CONSOL Energy was not alone in getting a boost since last week's presidential debate, which Republican nominee Mitt Romney used as a platform to reiterate his support for the coal industry. Nevertheless CONSOL and Cameco are still trading slightly above their respective Graham numbers, and upcoming earnings will be worth keeping an eye on to see if this changes for the better.

On the other hand, Walter Energy has been beaten down within shouting distance of its 52-week low, though future performance may be reliant on an increased demand for steel, which in turn would increase the demand for metallurgical coal like Walter produces. Finally, I included Yanzhou Coal on this list partially for its growth potential in relation to its Graham number, but also because it's "on the ground" as a large coal producer in China, the world's largest consumer of coal.

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 is not the cheapest here, it still has plenty of room to grow into its Graham number valuation, so I will be placing a "thumbs-up" over on my CAPS page in order to track this call and keep myself accountable. 

Coal may be looking back at its best days, but with the swelling of the global middle class, energy consumption will skyrocket over the next few decades and with it the importance to find a worthwhile energy stock. We've picked one incredible natural gas company that presents a rare "double-play" investment opportunity today. We're calling it "The One Energy Stock You Must Own Before 2014," and you can uncover it today, totally free, in our premium research report. Click here to read more.


 

Fool contributor Robert Eberhard has no positions in the stocks mentioned above. Follow him on Twitter, or click here to see his holdings and a short bio. The Motley Fool has no positions in the stocks mentioned above. 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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