Investing 101: Large-Cap Stocks Undervalued by Graham's Equation

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Stocks with large market caps are generally less volatile than those with small market caps. If stability is a concern for you, and if you're interested in finding potentially undervalued stocks for your portfolio, this list may be a great starting point for your search.

To create our list we started with a universe of large-cap stocks, or companies with market value above $10 billion, and applied the Graham Number.

According to Benjamin Graham, a former mentor of Warren Buffett and the so-called "Godfather" of value investing, the Graham Number is the maximum price that a value investor should pay for a given stock. A stock whose share price is below the Graham Number is considered to be undervalued or of good value.

It is a calculation for the fair-value price of a stock based on its earnings per share (EPS) and book value per share (the value of the company's assets divided by the number of shares).

The Graham Number = Square Root of (22.5) x (TTM EPS) x (MRQ Book Value per Share).

Note: The market does not price stocks based on the Graham Number, so share prices could increase significantly above the Graham Number, or fall far below it. This is also just one of many ways to value a stock.

The following is a list of the most undervalued large-cap stocks according to the Graham number. Do you feel these names offer the stability and growth potential you're searching for?

Use the list below, sorted by potential upside, as a starting-off point for your own analysis. (Click here to access free, interactive tools to analyze these ideas.)

1. Chevron (NYS: CVX) : Engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. Diluted TTM earnings per share at 11.45, and a MRQ book value per share value at 57.74, implies a Graham Number fair value = sqrt (22.5*11.45*57.74) = $121.96. Based on the stock's price at $98.52, this implies a potential upside of 23.8% from current levels. It's worth pointing out that the stock has a low short float (currently at 1.33%), which may suggest that sophisticated investors, like short-sellers, think the stock's upside potential outweighs the downside.

2. AT&T (NYS: T) : Provides telecommunication services to consumers, businesses, and other service providers worldwide. Diluted TTM earnings per share at 3.44, and a MRQ book value per share value at 19.21, implies a Graham Number fair value = sqrt(22.5*3.44*19.21) = $38.56. Based on the stock's price at $28.27, this implies a potential upside of 36.4% from current levels.

3. US Bancorp (NYS: USB) : Provides various banking and financial services in the United States. Diluted TTM earnings per share at 2.06, and a MRQ book value per share value at 15.5, implies a Graham Number fair value = sqrt(22.5*2.06*15.5) = $26.80. Based on the stock's price at $22.66, this implies a potential upside of 18.29% from current levels.

4. Apache (NYS: APA) : Operates as an independent energy company. Diluted TTM earnings per share at 9.95, and a MRQ book value per share value at 66.28, implies a Graham Number fair value = sqrt(22.5*9.95*66.28) = $121.81. Based on the stock's price at $101.75, this implies a potential upside of 19.72% from current levels

5. Time Warner (NYS: TWX) : Operates as a media and entertainment company in the United States and internationally. Diluted TTM earnings per share at 2.32, and a MRQ book value per share value at 30.15, implies a Graham Number fair value = sqrt(22.5*2.32*30.15) = $39.67. Based on the stock's price at $31.3, this implies a potential upside of 26.75% from current levels.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.


Kapitall's Becca Lipman does not own any of the shares mentioned above.

At the time this article was published Motley Fool newsletter services have recommended buying shares of Chevron and AT&T. 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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