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 valuing 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.

A quick check can help determine whether 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 exceeded a P/B of 1.5 but still met the ideal situation mentioned above. Currently, there are 68 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 electric utility American Electric Power Co. (NYSE: AEP).

Who is it?
American Electric Power provides electricity to 5.3 million customers, primarily in the Midwest. The company owns approximately 38,000 megawatts of generating capacity and the largest electricity transmission system in the country. This massive distribution network has allowed the utility to prosper, and a recent rate increase in Ohio should further buoy the top line.

AEP joins other utilities in paying a decent dividend, with its recent yield checking in at a respectable 4.4%. This payment appears sustainable, with the company paying out only a modest 45.6% of its earnings as a dividend. Compare that to a larger utility like Southern Co. (NYSE: SO), which pays out more than 76% of earnings but sports a lower yield. This leads me to believe that AEP can continue to grow its dividend.

What's it worth?
Beyond its dividend, AEP is also cheap according to its Graham number, joining PPL Corp. (NYSE: PPL) with some upside. This is despite being within 2% of its 52-week high:



Book Value per Share (MRQ)

Graham Number

Recent Price

Upside / (Downside)

American Electric Power Company $4.11 $30.94 $53.49 $43.11 24.1%
PPL Corp. $2.94 $18.89 $35.35 $29.49 19.9%
FirstEnergy Corp. (NYSE: FE) $2.68 $32.27 $44.11 $45.99 (4.1%)
NextEra Energy (NYSE: NEE) $5.13 $37.35 $65.66 $69.03 (4.9%)
Consolidated Edison $3.62 $39.53 $56.74 $61.96 (8.4%)

Source: Yahoo! Finance and author's calculations. TTM = trailing 12 months; MRQ = most recent quarter.

PPL is a favorite among income investors because of its yield near 5%. But it has also grown its dividend every year since 1999, giving investors even more incentive to love the company. Its well-diversified operations in the U.S. and U.K. have also helped it report double-digit revenue increases, on average, over the past three quarters.

FirstEnergy also sports a yield near 5%, and a miss on EPS pushed its share price down the day of its earnings release, making it even cheaper than it was earlier this month. My Foolish colleague Mark Reeth cites NextEra as a potential growth candidate in the staid utilities sector, though its current price is slightly above its Graham number. It does, however, have the highest EPS of the stocks on my list. Finally, Consolidated Edison has crushed the S&P 500 index over the past three decades, even if earnings growth has slowed recently for the venerable utility.

Accountability time
Utility stocks tend to be considered low-risk propositions since they provide the resources that people need to live their daily lives. This does not mean utilities should be purchased at any price. The Graham number is but one thing you can look at when valuing companies, and by this metric, American Electric Power is considered cheap. Therefore, I will be holding myself accountable on this call by placing a "thumbs up" over on my CAPS page. I will also be adding American Electric Power to My Watchlist to keep an eye on the company and make sure that nothing dramatic happens that would affect my opinion on the company.

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Fool contributor Robert Eberhard holds no position in any company mentioned. Follow him on Twitter, or click here to see his holdings and a short bio. Motley Fool newsletter services have recommended buying shares of Southern. The Motley Fool has a disclosure policy.

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