NCAV investing is a bargain investing strategy involving buying stocks when they are selling for less than you’re likely to receive even in the harshest firesale of its assets.
Benjamin Graham was the tutor of Warren Buffett and the father of security analysis. He was a very successful investor and left behind a ream of literature for both professional and private investors. One of his most famous strategies was to buy well diversified portfolios of companies that were selling at bargain basement prices. His definition of what was a bargain would vary, but in his book “Security Analysis” he defined one such methodology as follows.
He reasoned that a company must be worth more than what equity investors would receive in a firesale of its most easily sellable assets. In a firesale of assets it may not be possible to sell fixed assets such as property or equipment quickly so he excluded them from his calculation. He added up all the current assets (cash, stocks and debtors) and subtracted from them everything that the company owed (i.e. all debts as they will need to be reimbursed first). The leftover value he called the ‘net current asset value’.
If the current market value of a company is less than this net current asset value, then he reasoned that the stock would qualify as a bargain and should be bought as part of a well diversifed portfolio. If the company did go bust, the idea is that you would have the protection of knowing that all creditors could be paid back from current assets and the fixed assets would be thrown in for free.
Why the diversification? Well, the kinds of stocks that qualify as such bargains tend to be being thrown away by the investment community because they are too small, too unprofitable, too unfashionable or too close to bankruptcy. As a result they are inherently risky individually but in aggregate, Graham reasoned, these individual risks could be diversified away.
- Graham considered Preferred Stock to be a form of liability as it is senior to common stock. As a result he subtracted it from current assets in the calculation.
- Ben Graham aimed to buy companies at 66% of the NCAV value, although these days it is getting much harder to buy these kinds of bargains and some investors suggest extending the…