STOCKS

These three companies just raised earnings estimates and their stocks are ultra-cheap according to a valuation method derived by the legendary Benjamin Graham. Bargain hunters, take note.

Below is a list of three companies that have recently raised earnings guidance above analysts’ estimates. Interestingly, these companies are also undervalued according to the “Graham Number.”

Benjamin Graham, the man who developed this equation, was a former mentor of Warren Buffett and is the so-called “Godfather” of value investing.

The Graham Number, or the maximum price an investor should pay for a stock, is derived using only two data points: current earnings per share and current book value per share.

The Graham Number = Fair Value of a Stock = Square Root of (22.5) x (TTM Earnings per Share) x (MRQ Book Value per Share).

(TTM: Trailing 12 Month; MRQ: Most Recent Quarter)

The math of the Graham number is relatively straightforward. It is predicated on the belief that the price-to-earnings-per-share (P/EPS) ratio should be no more than 15, and the price-to-book-value (P/BVPS) ratio should be no more than 1.5. Therefore we only include companies that meet both of these criteria.

From these criteria, the product of the two should not be more than 22.5. In other words, (P/EPS of 15) x (P/BVPS of 1.5) = 22.5, from which the equation was created.

Do you think the news of higher earnings has been priced into these names, or are they undervalued relative to their performance? Read below, using this list as a starting point for your own analysis into undervalued opportunities.

List sorted by potential upside implied by the Graham Number.

GameStop Corp. (GME) is in the electronics retail stores industry and has a market cap of $3.33 billion.

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The company guided Q1 at $0.53-$0.55 versus analysts' estimate of $0.51. The Graham Number = square root of (22.5 x $18.30 x $2.45) = $31.76. At the current price of around $22.31, that implies a potential upside of 42.36%.

The stock is a short squeeze candidate with a short float at 25.69% (equivalent to 8.96 days of average volume). The stock has had a good month, gaining 10.68%.

Aetna Inc. (AET) is in the health care plans industry and has a market cap of $14.18 billion.

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The company guided full-year 2011 at $3.70-$3.80 versus analysts' estimate of $3.27. The Graham number = square root of (22.5 x $25.73 x $4.18) = $49.19.

At the current price of around $36.99, that implies a potential upside of 32.99%. The stock has gained 5.76% over the last year.

Entergy Corporation (ETR) is in the electric utilities industry and has a market cap of $11.91 billion.

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The company guided Q4 at $1.29 versus analysts' estimate of $1.20. The Graham number = square root of (22.5 x $47.53 x $6.66) = $84.39.

At the current price of around $67.39, that implies a potential upside of 25.23%. ETR has a relatively low correlation to the market (beta = 0.63), which may be appealing to risk-averse investors. The stock has lost 14.74% over the last year.

By the Staff at Kapitall.com

Tickers Mentioned: Tickers: GME, AET, ETR

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