Monday, March 10, 2008

Stock Market Value Investing Concepts - Net Current Asset Value

What is net current asset value (NCAV) and how can beginners apply it in stock market value investing?

Benjamin Graham, author of The Intelligent Investor, is credited with developing an investment strategy to find undervalued companies in the stock market by employing a measure called the Net Current Asset Value. Benjamin Graham was a big believer in buying stocks at a significant discount to their intrinsic value. His theory was that eventually the underlying value in the company would be reflected in the share price and in the worst case scenario, an investor would be protected from significant losses because the price of the stock shouldn't fall much further.

What Is Net Current Asset Value?

Put simply, net current asset value is the value of a company's current assets less all of it's liabilities. This means that you discard the value of any tangible non-current assets like plant and equipment as well as any intangible assets like goodwill. You only take into account current assets like cash (and cash equivalents), receivables and stock on hand. You then take away all liabilities - both current and non-current (this means things like long term debt, trade creditors and any provisions).

The idea is that this number (either on a per share or an aggregate basis) should be what a company is worth in the worth case scenario if the company is wound up. In the event of a company being wound up the value of assets like plant and equipment is normally greatly diminished and so is not taken into account in this calculation. In the other hand, all creditors will be lining up to claim what's owed to them, so all liabilities need to be considered at 100% of face value.

If you wanted to be even more conservative, you could discount the value of stock on hand as well, as the carrying value may not be realized in the case of a fire sale. You could discount it be 50% or even more.

The main concept to grasp with this stock investment strategy is that the net tangible asset value should be the absolute minimum amount that a company will be worth.

How Can Stock Market Investors Use Net Current Asset Value?

Benjamin Graham advocated a portfolio approach to value investing. He suggested buying a group of companies which exhibit favorable characteristics. In this way investors are further insulated from risk by minimizing the potential for a loss in any one company to cause significant pain to an investor.

Investors would buy and hold stocks in such a portfolio until either the value of any company was realized in it's share price, or the fundamentals of a company changed to such a degree that holding it was no longer deemed worthwhile.

How Can Investors Find These NCAV Bargains?

To my knowledge, there are no screens available to identify companies trading at a discount to their net current asset value. And it's not a figure that's published in any stock market data on any of the finance websites (Yahoo Finance and such).

Your best option is probably to find a short list of companies trading below their book value then work from there. Some sites allow you to display a selection of financial statistics and in addition apply a filter to the list. By selecting Current Assets, Current Liabilities, Non-Current Liabilities and Market Capitalization (or a similar set of statistics) then filtering on companies trading below book value, you should then be able to download the resulting data to a spreadsheet to complete your calculations.

However in my experience, patience is required. There have not been many companies trading at a discount to NCAV in recent times. I should say that in my search, I normally require a company to be profitable and also have a minimum market capitalization such that costs of liquidation wouldn't absorb all of the margin between the current price and the net current asset value.

Even if you don't find many prospects, you'll be surprised how much beginners can learn about stock market investing while doing this sort of in-depth analysis.


Anonymous said...

Thanks for the very interesting article. I had heard of Grahams theory before but never really got into it. Looked at other theories and mostly efficient market theories which kind of says by the index and all will be good.

Thanks for taking the time to share. Its appreciated. I will visit your site more too as I am interested in these topics.

aussie said...

Hi Durbanbay, you're most welcome. Read as much as you can - there's no single right way when you start investing in the stock market. Benjamin Graham has written a couple of great books - well worth putting the time aside to read them - but there are many other great books on stock market investing for beginners.

Adrian Chong said...

A screening tool for US stocks whose price below NCAV:

Recently I identified and bought USU, BZH and MHO using this screening. They gave very good return.


Anonymous said...

This is great. New to investing in the stock market and enjoying the journey:

It seems that it is important to know and understand the ratios that communicate the key factors of a potential investment. Also helpful in making comparisons with competitors.

I am finding this information on the blog very helpful.

Thank you for the posts.

Rakesh Nalkar said...

Interesting but you havent mentioned what the Ratio should be.If you consider, most of the companies NCAV will be Negative, do u mean there is no value in those companies?
This is baseless, i dont know how will this give out any indications about the Stocks value.

aussie said...

Hi Rakesh. Net Current Asset Value is not a ratio but rather an absolute value. However by it's very nature, the value is stock specific.

As a ratio, you would look at Price / NCAV and you would be looking for a value of less than one (I think Benjamin Graham actually looked for a value closer to two thirds). You are correct that most companies would not meet this criteria and at times almost no companies meet this criteria.

I should probably clear up one last thing - just because a company does not meet this criteria, does not mean there is no value in its stock. On the contrary, there are some great companies which never meet this criteria but which are well worth buying.

But I think what Benjamin Graham liked about using this measure was it's objectivity - the stock either met the test or it didn't. It takes more skill to place a value on the intangibles which give some companies their value. It can be done, as Warren Buffett has proved on many occasions, but it is a difficult task for most stock market beginners.

Vikas Modi said...

currently, I am accumlating hb portfolio Ltd. I had read analysis of HB portfolio Ltd on . It is compelling value buy at current has total investment Stock(185) + MF(10 ) + Unquoted(39) = 234 crores. and company is also having Net Current Asset around 47 crores (including 14cr cash) on consolidated balance sheet . So on market cap of 60, we are getting company ,which has investment 234 + Net Current Asset 47 = 271 crores and fixed asset extra.Can you please give me your input about HB portfolio Ltd ?

I had viewed analysis of this stock from blog

Global finance school said...

This article give the idea of investing concept in stock market its very useful for me.. thanks.

Anonymous said...

Thank you so much for such useful information! Quick q - you mention comparing stocks with other stocks in the same industry to figure out if the stock is undervalued BUT where do I start? How do I know what industry or stock is best to start researching to invest in?


Understanding stocks can sometimes be a little confusing to the novice. New investors can always start out owning a few exchange traded funds until they feel confident enough to buy single stocks.

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