Graham combined requirements for P/E and price/book ratios into a metric that is famously known as the Graham number. You calculate a company’s Graham number by multiplying the ratio of price to the average earnings (of the past three years) by the price to book ratio. Graham’s suggested upper limit for the ratio was 22.5.
Caterpillar Inc. (NYSE:CAT) fails the test with a Graham number of 36.6. BHP also fails, although just barely, with a Graham number of 23.25. With a Graham number of 18.23, Chevron Corporation (NYSE:CVX) is the only company of these three that passes the test
Foolish final thoughts
Benjamin Graham was an absolute genius when it came to analyzing stocks. He was an enterprising investor who put massive mental efforts into finding the markets best stocks. But he knew that, while everyone wants to make money with common stocks, not everyone would enjoy spending as much time studying them as he did.
Thankfully for the defensive investors out there, Graham outlined seven key statistical requirements that a stock ought to meet in order to be included in a defensive investor’s portfolio. Checking to see if a company meets the requirements is incredibly simple.
Here, we have three companies, none of which meet all seven requirements. I’m not sure if there is a stock out there that does right now. However, all three of these enterprises come awfully darn close to meeting all seven of Grahams requirements. BHP and Chevron Corporation (NYSE:CVX) both appear to be cheaper than Caterpillar Inc. (NYSE:CAT). But I’d bet that buying any of these companies, at current prices, will produce satisfactory returns for the defensive investor.
Fool blogger Ryan Palmer has no position in any of the stocks mentioned. The Motley Fool recommends Chevron.
The article Ben Graham’s Seven Statistical Requirements originally appeared on Fool.com.
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