Appendix B
The Graham analysis contains the following criteria:
- Sufficient size
- Strong financial condition
- Earnings stability
- Dividend record
- Earnings growth
- Moderate P/E ratio
- Moderate Price to Assets Ratio
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The International Business Machines Corporation [IBM]
All data dated as of 17 April 2008
a. P/E Ratio – 16.77
b. Dividend Yield – 1.4%
c. Price – 120.47 USD
Application of Graham Analysis
Sufficient Size
Graham requires of an industrial company, adjusted for inflation, annual sales of 465 million. Based on figures from fiscal year ending 31 December 2007, IBM had total revenues in the amount of 98.79 billion USD. Clearly the company is of sufficient size under the Graham analysis.
Strong Financial Condition
Graham requires a current ratio of at least 2 and that long-term debt should not exceed working capital by that ratio. The objective is to provide protection against bankruptcy. Current ration is calculated by the following formula: CR = CA/CL.
Based on IBM’s Balance Sheet for 31 December 2007, it had current assets in the amount of 53,177,000 [all numbers in thousands] and it had current liabilities in the amount of 44,310,000. The CR is 53,177,000/44,310,000 or a ration of 1.2. In itself, the current ration fails to meet the Graham minimum requirement of 2 as the higher the number the more capacity of the company to pay debts.
IBM has long-term debt of 23,573,000. Working capital is derived by the formula WC = CA-CL.
Therefore, IBM has WC equal to 53,177,000 – 44,310,000 or 8,867,000. The ration of long-term debt to WE is equal to 23,573,000/8,867,000 or 2.658%. Since that ration exceeds the CR of 1.2, IBM fails to meet the “sufficiently strong financial condition” criteria of the Graham analysis.
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Earnings Stability
Graham defines earnings stability as not having reported a loss over a period of ten years. These figures were drawn from the IBM archives available on the IBM website.
| Year | Net Income [in Billions] |
| 1998 | 6.32 |
| 1999 | 7.7 |
| 2000 | 8.1 |
| 2001 | 7.7 |
| 2002 | 3.58 |
| 2003 | 7.6 |
| 2004 | 8.4 |
| 2005 | 7.9 |
| 2006 | 9.4 |
| 2007 | 10.4 |
Accordingly, IBM meets the “earnings stability” test.
Dividend Record
Graham requires that a company have a history of paying dividends on its common stock for the past twenty years to assure that dividends are like to be paid.
A review of the historical records for dividend payments available on the IBM Website shows that IBM has consistently paid a dividend to common shareholders for the past 20 years 1987 through 2008. Therefore, the dividend record requirement of the Graham analysis is met.
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Earnings Growth
Graham states that net income should have increased by one-third or greater on a per share basis over the course of the past ten years using three-year averages at the beginning and end of the period.
| Year | EPS |
| 2007 | 7.18 |
| 2006 | 6.11 |
| 2005 | 4.87 |
| Average | 6.05 |
| 1999 | 4.12 |
| 1998 | 3.29 |
| 1997 | 3.00 |
| Average | 3.47 |
Result: The increase is approximately 57%; therefore, the Graham criterion is met.
Moderate Price to Earnings Ratio
The P/E should not exceed 15 times its average earnings over the past three years. Data was compiled by dividing Price at year’s end by EPS for year. Data to compute numbers was taken from IBM financial statements.
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| Year | P/E |
| 2007 | 16.77 |
| 2006 | 15.9 |
| 2005 | 17.3 |
Technically, though close, IBM’s P/E for the last three years exceeds Graham’s criterion that the P/E not exceed 15 times earnings.
Moderate Ratio of Price to Assets
Graham states that current price should not exceed 1 and one-half times the last reported book value.
According to MSN Finance, key ratios, the current price to book value is 5.81. Therefore, IBM fails to meet the Graham criterion. However, if we look at Price to Assets, the conclusion may differ. The total assets are 120,432,000 [in thousands] and the price is 120.47 demonstrates a moderate price in relation to total assets.
Conclusion
The financial data for IBM does not satisfy all Graham criteria. IBM meets sufficient size, dividend record, earnings growth, and earnings stability. It does not meet P/E ratio, Price to Assets ratio, and strong financial condition.
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