Discover the legendary valuation method from "The Intelligent Investor" and see how StoQuant applies it to identify undervalued stocks daily.
Benjamin Graham, the father of value investing, published his intrinsic-value formula in "The Intelligent Investor" (1962). The formula is elegantly simple: V = EPS × (8.5 + 2g), where EPS is the earnings per share and g is the expected annual growth rate as a percentage. This formula estimates what a stock should theoretically be worth based on its current earnings and expected growth, independent of market sentiment or hype. Graham's formula rests on two core assumptions: first, that a reasonable investor should be willing to pay 8.5 times earnings for a zero-growth stock (reflecting the earnings yield), and second, that each percentage point of annual growth justifies an additional 2× multiple. For example, a stock with $1 EPS and 10% expected growth would have intrinsic value of $1 × (8.5 + 20) = $28.50. If the stock trades at $18, it may be undervalued; if it trades at $40, it may be overpriced. The strength of the Graham formula is its simplicity and discipline. Unlike complex discounted-cash-flow models that hinge on dozens of assumptions, the Graham formula forces investors to ask two clear questions: what is the company earning right now, and what is reasonable growth to expect? It also has a long history of success: value investors who have used Graham's methodology (Warren Buffett, among many others) have generated substantial long-term returns. However, the formula has limitations. It assumes that earnings are stable or predictable, which is not always true for cyclical or distressed companies. It does not account for capital structure, competitive moats, or industry-specific dynamics. And it uses a fixed multiple for growth, which may not reflect the reality that high-growth companies command different valuations than low-growth ones.
While the Graham formula is timeless, modern practitioners adjust it for inflation, interest rates, and market conditions. When AAA bond yields are at 4.4% (as they were in Graham's era), the 8.5 base multiple is appropriate. But if yields rise to 5.5%, the earnings multiple should fall to reflect the higher cost of capital. StoQuant dynamically adjusts the base multiple: higher rates = lower earnings multiples. Another adjustment addresses growth-rate capping. Graham suggested 15–20% as the maximum reasonable growth rate to prevent excessive optimism. StoQuant enforces a 15% cap: any analyst consensus forecast above 15% is capped at 15% for the formula. This guards against inflated valuations in high-growth tech stocks. Critics of the Graham formula point out that it conflates earnings quality with earnings quantity. A company reporting $1 EPS through accounting tricks is not equivalent to one earning $1 through real operational excellence. To address this, StoQuant applies qualitative filters: we verify earnings through free cash flow, check for red flags in SEC filings (10-K risk factors, restatements), and exclude companies with negative operating cash flow. Additionally, the formula assumes mean reversion: that growth rates eventually normalize. For disruptive tech companies or structural winners (e.g., network effects), this assumption may not hold. The most persistent criticism is survivorship bias: the formula was backtested on historical data, and we know which companies thrived. Applying the formula to forward-looking investments requires judgment. StoQuant mitigates this by combining the Graham formula with Hidden Markov Model regime detection (to avoid overvaluing in bear markets) and machine learning (to weight the formula more heavily when market regimes favor value). Despite these limitations, the Benjamin Graham formula remains one of the most reliable tools for identifying undervalued small caps. A 30% margin of safety provides a buffer against error, and decades of research confirm that value-investing strategies (of which Graham's formula is a cornerstone) outperform the broad market over long time horizons.
Apply the formula: Intrinsic Value Calculator (stoquant.com/intrinsic-value-calculator) and Undervalued Small Cap Stocks (stoquant.com/undervalued-small-cap-stocks). See also the companion concept: Margin of Safety (stoquant.com/learn/margin-of-safety).
EPS stands for earnings per share, calculated as net income divided by the number of outstanding shares. StoQuant uses the trailing 12-month (TTM) EPS from FMP fundamentals data.
Use historical earnings growth over the past 5 years as a baseline, then adjust for forward expectations. Analyst consensus estimates are a good starting point. Graham recommended capping at 15–20% to avoid overoptimism; StoQuant caps at 15%.
Graham derived these from the AAA corporate bond yield of his era (~4.4%). The 8.5 represents a reasonable earnings multiple for no growth; the 2 represents how much additional multiple to grant per percentage point of growth. Modern practitioners adjust 8.5 based on current interest rates.
The margin of safety is the percentage discount between a stock's current price and its intrinsic value. Graham suggested buying only when a stock trades at least 30% below its intrinsic value, providing a buffer against errors in estimation.
The formula struggles with highly cyclical businesses, unprofitable growth companies, and firms with unstable earnings. It also assumes that analyst forecasts are accurate, which is not always true. StoQuant uses additional filters (free cash flow, debt-to-equity, 10-K risk signals) to validate earnings quality.
StoQuant calculates intrinsic value daily for all 822 stocks using the Graham formula with modern adjustments (rate-based multiple scaling, 15% growth cap, earnings-quality filters). Stocks trading at a 30%+ margin of safety are flagged in the hidden-gem screen and scored higher in the Q-Score valuation dimension.