ruly P/E × price to book: the Graham product
What the product of the P/E and price to book measures, where the 22.5 threshold comes from, how to calculate it from an annual report, its traps and the sectors it does not suit.
Published
Definition
The product of the P/E and the price to book ratio combines two valuation measures into one. It accepts a slightly higher P/E when the share is cheap relative to its equity, and a higher price to book when the P/E is low. It therefore avoids ruling out a company that only narrowly misses one of the two thresholds.
Formula
P/E × price to book = (share price / earnings per share) × (share price / book value per share)
Where to find it in an annual report
Earnings per share appear at the bottom of the income statement. Book value per share is calculated from equity attributable to the parent on the balance sheet, divided by the number of shares outstanding from the note on share capital. In the app, you enter both ratios and the app works out the product.
Common thresholds
Value: 22.5 at most for green, up to 30 for orange, red above. The 22.5 threshold comes from Benjamin Graham’s “The Intelligent Investor”, where it is obtained by multiplying a P/E of 15 by a price to book of 1.5. It was aimed at industrial companies with tangible assets, and proves very selective in today’s markets.
In the preset strategies
| Preset strategy | Criterion met | To monitor | Criterion not met |
|---|---|---|---|
| Value (calculated) P/E × price / book value | 0 to 22.5 | 22.5 to 30 | > 30 or < 0 |
Pitfalls
- The product inherits the traps of both its parts: one-off earnings, intangible assets missing from the balance sheet, equity reduced by buybacks.
- A low product can come from a single extreme ratio: a price to book of 0.4 with a P/E of 50 gives 20, without the company being cheap on its earnings.
- The 22.5 threshold dates from a time when companies had more tangible assets: applied as it is to service companies, it rules out almost all of them.
Where it does not apply
- Companies whose value is mainly intangible (software, brands, services): their price to book is structurally high.
- Loss-making companies or those with negative equity: one of the two ratios makes no sense.
A worked example
A fictitious company, called Company W here, has a P/E of 13 and a price to book of 1.6. On price to book alone, it exceeds the green threshold of 1.5. The product is 13 × 1.6 = 20.8: below 22.5, it stays green, because the low P/E makes up for it.
Why a product
The two ratios measure the same thing from two angles: what you pay relative to what the company earns, and relative to what it owns. Multiplying them allows a trade-off between the two. See the P/E ratio and price to book entries.
Sources
- Benjamin Graham, “The Intelligent Investor” (criteria for the defensive investor)
- Annual reports of listed companies (income statement, balance sheet)