Graham Number: Why Facebook Doesn't Make the Value Cut

Despite Facebook's (FB) IPO disappointment, many investors are still eager to buy shares of the firm because of the familiarity and hype. But be warned: buying and holding a stock based on speculation and hype is generally frowned upon.

Forbes reminds us that Benjamin Graham, a former mentor of Warren Buffett and "Godfather" of value investing, would not have touched Facebook stock.

In his acclaimed book, The Intelligent Investor, Graham writes that speculation is primarily "anticipating and profiting from market fluctuations," while investing is "acquiring and holding suitable securities at suitable prices." He argues price value matters when investing, and undervalued companies are considered less risky.

Facebook, whose IPO opened at $38 on May 18, could be considered excessively overvalued (very risky). That overvaluation implies that most buyers are expecting to take advantage of the "hotness" of the stock, which is speculating on price movement, and not very interested in much else. In essence, buying Facebook stock is far from investing.

Business section: Investing ideas
Since investors should rationally prefer to reduce risk, we put together a list of stocks that are considered undervalued by Graham's signature method: The Graham Number.

The Graham Number is a calculation for the maximum fair-value price of a stock. It is based on its earnings per share (EPS) and book value per share. Stocks trading significantly below their Graham Number are considered to be potentially undervalued.

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

We also looked for stocks trading within 10% of their 52-week highs, a sign of positive momentum.

List sorted by market cap. Do you think these stocks have more room to run? (Click here to access free, interactive tools to analyze these ideas.)

1. Wells Fargo (NYS: WFC) : Provides retail, commercial, and corporate banking services primarily in the United States. Market cap at $164.41B, most recent closing price at $31.19. The stock is currently trading at 9.98% below its 52-week high. Diluted TTM earnings per share at 2.9, and a MRQ book value per share value at 25.45, implies a Graham Number fair value = sqrt(22.5*2.9*25.45) = $40.75. Based on the stock's price at $32.69, this implies a potential upside of 24.66% from current levels.

2. PNC Financial Services Group (NYS: PNC) : Operates as a diversified financial services company. Market cap at $32.59B, most recent closing price at $61.82. The stock is currently trading at 9.66% below its 52-week high. Diluted TTM earnings per share at 5.51, and a MRQ book value per share value at 63.27, implies a Graham Number fair value = sqrt(22.5*5.51*63.27) = $88.57. Based on the stock's price at $64.85, this implies a potential upside of 36.57% from current levels.

3. The Chubb Corporation: Provides property and casualty insurance to businesses and individuals. Market cap at $19.26B, most recent closing price at $71.36. The stock is currently trading at 4.84% below its 52-week high. Diluted TTM earnings per share at 5.86, and a MRQ book value per share value at 57.38, implies a Graham Number fair value = sqrt(22.5*5.86*57.38) = $86.98. Based on the stock's price at $73.54, this implies a potential upside of 18.28% from current levels.

4. American Electric Power (NYS: AEP) : Engages in the generation, transmission, and distribution of electric power to retail customers. Market cap at $18.28B, most recent closing price at $37.62. The stock is currently trading at 7.88% below its 52-week high. Diluted TTM earnings per share at 4.09, and a MRQ book value per share value at 30.69, implies a Graham Number fair value = sqrt(22.5*4.09*30.69) = $53.14. Based on the stock's price at $38.35, this implies a potential upside of 38.58% from current levels.

5. Discover Financial Services: Operates as a credit card issuer and electronic payment services company primarily in the United States. Market cap at $16.72B, most recent closing price at $31.75. The stock is currently trading at 9.29% below its 52-week high. Diluted TTM earnings per share at 4.4, and a MRQ book value per share value at 16.66, implies a Graham Number fair value = sqrt(22.5*4.4*16.66) = $40.61. Based on the stock's price at $33.89, this implies a potential upside of 19.83% from current levels.

6. Allstate: Engages in the personal property and casualty insurance, life insurance, retirement, and investment products businesses primarily in the United States. Market cap at $16.2B, most recent closing price at $33.03. The stock is currently trading at 6.40% below its 52-week high. Diluted TTM earnings per share at 2.01, and a MRQ book value per share value at 38.91, implies a Graham Number fair value = sqrt(22.5*2.01*38.91) = $41.95. Based on the stock's price at $34.83, this implies a potential upside of 20.44% from current levels.

7. Public Service Enterprise Group: Operates in the energy industry primarily in the northeastern and mid Atlantic United States. Market cap at $16.01B, most recent closing price at $31.81. The stock is currently trading at 8.69% below its 52-week high. Diluted TTM earnings per share at 2.89, and a MRQ book value per share value at 21, implies a Graham Number fair value = sqrt(22.5*2.89*21) = $36.95. Based on the stock's price at $31.89, this implies a potential upside of 15.88% from current levels.

8. PPL Corporation (NYS: PPL) : Generates and sells electricity; and delivers natural gas to approximately 5.3 million utility customers primarily in the northeastern and northwestern US. Market cap at $15.77B, most recent closing price at $27.44. The stock is currently trading at 7.93% below its 52-week high. Diluted TTM earnings per share at 2.83, and a MRQ book value per share value at 19.44, implies a Graham Number fair value = sqrt(22.5*2.83*19.44) = $35.18. Based on the stock's price at $27.44, this implies a potential upside of 28.22% from current levels.

9. Loews Corporation (NYS: L) : Operates primarily as a commercial property and casualty insurance company in the United States. Market cap at $15.37B, most recent closing price at $38.64. The stock is currently trading at 9.67% below its 52-week high. Diluted TTM earnings per share at 2.62, and a MRQ book value per share value at 48.96, implies a Graham Number fair value = sqrt(22.5*2.62*48.96) = $53.72. Based on the stock's price at $40.43, this implies a potential upside of 32.88% from current levels.

10. M&T Bank: Operates as the holding company for M&T Bank and M&T Bank, National Association that provide commercial and retail banking services to individuals, corporations and other businesses, and institutions. Market cap at $10.28B, most recent closing price at $81.23. The stock is currently trading at 8.28% below its 52-week high. Diluted TTM earnings per share at 6.26, and a MRQ book value per share value at 67.67, implies a Graham Number fair value = sqrt(22.5*6.26*67.67) = $97.63. Based on the stock's price at $84.6, this implies a potential upside of 15.4% 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 Danny Guttridge does not own any of the shares mentioned above. Profitability data sourced from Fidelity, EPS and BVPS data sourced from Yahoo! Finance, all other data sourced from Finviz.

At the time thisarticle was published The Motley Fool owns shares of PNC Financial Services Group. The Fool owns shares of and has created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo. The Motley Fool has a disclosure policy.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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