Before jumping into a new stock investment, it’s important to exercise due diligence and look at a few things – important among them is market sentiment.

Is the market recently bullish on the company? Has it taken a turn for the worse? One way to address these questions is by looking at the stock’s put option / call option ratio (otherwise known as the “put/call”).

Put options are the option to sell the stock at a future date and price, whereas a call option is the option to buy the stock. Because puts are profitable when the stock declines and calls are profitable when the stock rises, changes in the ratio of puts to calls indicates if more investors are bearish or bullish on a stock’s short-term outlook.

Another important part of stock due diligence is valuation – whether a stock is trading at a “fair price.”

One way to find this fair price is by using the Graham number equation, which calculates the maximum fair value of a stock based on its P/E and price-to-book-value ratio. The equation was created by Benjamin Graham, also known as the “godfather of value investing.”

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

This equation assumes that a stock is overvalued if P/E is over 15 or P/BV is over 1.5.

To help you find a starting point for your own analysis, we ran a screen on stocks that are trading at significant discounts to their Graham numbers. We screened these stocks for those with bullish changes (i.e. decreases) in put/call ratio over the last ten trading days.

Do you think these stocks should be trading higher?

* 1. Diodes Incorporated * (DIOD, Earnings, Analysts, Financials): Diodes Inc. and its subsidiaries make and distribute standard semiconductor products to manufacturers in the consumer electronic, computer, communications, industrial, and automotive markets. Open interest Put/Call ratio changed from 0.74 to 0.07 between 09/21/11 to 10/04/11, a change of -90.54%. Diluted TTM earnings per share at 1.78, and a MRQ book value per share value at 13.2, implies a Graham Number fair value = sqrt(22.5*1.78*13.2) = $22.99. Based on the stock's price at $17.4, this implies a potential upside of 32.14% from current levels.

* 2. Denbury Resources Inc. * (DNR, Earnings, Analysts, Financials): Engages in the acquisition, exploitation, drilling, and extraction of oil and natural gas properties in the Gulf Coast region located in Mississippi, Texas, Louisiana, and Alabama. Open interest Put/Call ratio changed from 0.5 to 0.16 between 09/21/11 to 10/04/11, a change of -68.0%. Diluted TTM earnings per share at 0.71, and a MRQ book value per share value at 11.66, implies a Graham Number fair value = sqrt(22.5*0.71*11.66) = $13.65. Based on the stock's price at $10.69, this implies a potential upside of 27.67% from current levels.

* 3. Altra Holdings, Inc. * (AIMC, Earnings, Analysts, Financials): Designs, produces, and markets a range of mechanical power transmission and motion control products worldwide. Open interest Put/Call ratio changed from 0.57 to 0.19 between 09/21/11 to 10/04/11, a change of -66.67%. Diluted TTM earnings per share at 1.18, and a MRQ book value per share value at 7.77, implies a Graham Number fair value = sqrt(22.5*1.18*7.77) = $14.36. Based on the stock's price at $10.57, this implies a potential upside of 35.88% from current levels.

* 4. GrafTech International Ltd.* (GTI, Earnings, Analysts, Financials): GrafTech International Ltd. manufactures graphite and carbon material science-based solutions. Open interest Put/Call ratio changed from 0.9 to 0.35 between 09/21/11 to 10/04/11, a change of -61.11%. Diluted TTM earnings per share at 1.13, and a MRQ book value per share value at 9.06, implies a Graham Number fair value = sqrt(22.5*1.13*9.06) = $15.18. Based on the stock's price at $12.55, this implies a potential upside of 20.93% from current levels.

* 5. Great Plains Energy Incorporated* (GXP, Earnings, Analysts, Financials): Engages in the generation, transmission, distribution, and sale of electricity in the United States. Open interest Put/Call ratio changed from 0.71 to 0.35 between 09/21/11 to 10/04/11, a change of -50.70%. Diluted TTM earnings per share at 1.24, and a MRQ book value per share value at 21.23, implies a Graham Number fair value = sqrt(22.5*1.24*21.23) = $24.34. Based on the stock's price at $18.37, this implies a potential upside of 32.49% from current levels.

* 6. Great Lakes Dredge & Dock Corporation* (GLDD, Earnings, Analysts, Financials): Engages in the business of marine construction, primarily dredging, and commercial and industrial demolition principally in the east, west, and Gulf Coasts of the United States. Open interest Put/Call ratio changed from 0.22 to 0.12 between 09/21/11 to 10/04/11, a change of -45.45%. Diluted TTM earnings per share at 0.32, and a MRQ book value per share value at 4.77, implies a Graham Number fair value = sqrt(22.5*0.32*4.77) = $5.86. Based on the stock's price at $4.24, this implies a potential upside of 38.22% from current levels.

* 7. Peabody Energy Corp.* (BTU, Earnings, Analysts, Financials): Engages in the exploration, mining, and production of coal. Open interest Put/Call ratio changed from 0.74 to 0.54 between 09/21/11 to 10/04/11, a change of -27.03%. Diluted TTM earnings per share at 3.28, and a MRQ book value per share value at 19.26, implies a Graham Number fair value = sqrt(22.5*3.28*19.26) = $37.70. Based on the stock's price at $31.86, this implies a potential upside of 18.33% from current levels.

* 8. HB Fuller Co.* (FUL, Earnings, Analysts, Financials): H.B. Fuller Company formulates, manufactures, and markets adhesives, sealants, paints, and other specialty chemical products worldwide. Open interest Put/Call ratio changed from 0.21 to 0.17 between 09/21/11 to 10/04/11, a change of -19.05%. Diluted TTM earnings per share at 1.7, and a MRQ book value per share value at 15.23, implies a Graham Number fair value = sqrt(22.5*1.7*15.23) = $24.14. Based on the stock's price at $17.3, this implies a potential upside of 39.51% from current levels.

*(Written by Alexander Crawford, list compiled by Eben Esterhuizen, CFA. Options data sourced from Schaeffer’s, BVPS and EPS data sourced from Yahoo! Finance.)*

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**Analyze These Ideas: Getting Started**

- Read descriptions for all companies mentioned
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**Dig Deeper: Access Company Snapshots, Charts, Filings**

- Diodes Incorporated (DIOD, Chart, Download SEC Filings)
- Denbury Resources Inc. (DNR, Chart, Download SEC Filings)
- Altra Holdings, Inc. (AIMC, Chart, Download SEC Filings)
- GrafTech International Ltd. (GTI, Chart, Download SEC Filings)
- Great Plains Energy Incorporated (GXP, Chart, Download SEC Filings)
- Great Lakes Dredge & Dock Corporation (GLDD, Chart, Download SEC Filings)
- Peabody Energy Corp. (BTU, Chart, Download SEC Filings)
- HB Fuller Co. (FUL, Chart, Download SEC Filings)

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