Graham Number is calculated as follows:
Graham Number = SquareRoot of (22.5 * Book Value * Earnings per share)
= Square Root of (22.5 * Net Income * Shareholder’s Equity) / Shares Outstanding
He wrote in "The Intelligent Investor" (1948 version) regarding to the criteria for purchases:
“Current price should not be more than 15 times average earnings of the past three years.”
“Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5. (This figure corresponds to 15 times earnings and 1.5 times book value. It would admit an issue selling at only 9 times earnings and 2.5 times asset value, etc.)”
Unlike valuation methods such as DCF or Discounted Earnings, the Graham number does not take growth into the valuation. Unlike the valuation methods based on book value alone, it takes into account the earnings power. Therefore, the Graham Number is a combination of asset valuation and earnings power valuation. the Graham number is a very conservative way of valuing a stock. It cannot be applied to companies with negative book values.