For investors keen to identify the ultimate value stocks, there is no shortage of investment philosophy and advice to put to the test – and among the most famous are the models formulated by the father of Value Investing - Benjamin Graham. With an approach that emerged from the grim days of the Great Depression, Graham’s techniques have gone on to become a vital tool for value hunters. Within his earliest work, Graham came up with a stringent value test that assesses a company based on the value of its current assets minus its total liabilities. It is a demanding screen to pass especially when market valuations are high, but research has shown that Net Current Asset Value – or NCAV stocks as they are known – offer investors significant potential gains.
Graham and his now legendary books, ‘Security Analysis’ and ‘The Intelligent Investor’ are firmly embedded in the foundations of conventional investment theory. For anyone that isn’t familiar with him, it is worth referring to the views of an equally high profile value investor for guidance – Warren Buffett – who credited his professor for shaping his well known and hugely successful investment philosophy:
Graham began penning his investment philosophy with the publication of Security Analysis in 1934, which was followed by the more accessible guide The Intelligent Investor in 1949. In The Intelligent Investor, Graham sets out two detailed screens for potential investors, one for “Defensive Investors” and another more demanding test for “Enterprising Investors”. As the original ‘quant’ on Wall Street, he aimed to invest purely on the basis of the undervaluation of bargain stocks, seeking safety from individual bankruptcy risk by diversifying his portfolio with a large numbers of companies – he suggested 30. While his legacy has tended to be dominated by his later work, the earlier formulas, in particular NCAV, remains a vital tool in identifying these undervalued stocks.
NCAV for deep value
NCAV is a deep value screen that values a company based on its Current Assets – think cash and cash equivalents, money it is owed and inventories – minus its Total Liabilities. The essence of the model is to identify bargain stocks that are trading at such a low price that they are unlikely to slip further. In the worst case, you would be able to liquidate the company and still emerge with a gain. To add…