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Sunday, 23 June 2013

Intrinsic Value Calculation - Net Current Asset Value (NCAV) Approach

The Net Current Asset Value (NCAV) approach was developed and tested by Benjamin Graham between 1930 and 1932. This is not exactly a method of determining the intrinsic value of companies but a strategy for identifying deep value stocks.

Graham includes only current assets in the computation of NCAV. While ignoring long-term assets, he includes everything that appears in the liabilities column of the balance sheet. In addition, Graham viewed that preferred stock belongs on the liability side of the balance sheet, not as part of capital and surplus. 

Formula : NCAV = Current Assets - [Total Liabilities + Preferred Stock]

Graham's NCAV strategy calls for buying stocks trading at not more than two-third of their net current asset value. This is a stringent requirement, but Graham was looking for companies trading so cheap that there was little danger of falling further.

Graham was well aware that some investments in companies that meet his NCAV criteria would fail, so he recommended buying a large number of stocks to diversify the risk. He suggested holding at least 30 stocks at a time. In addition, only companies with positive earnings in the last 12 months period are included in the portfolio. Graham would hold the investments until he had a 50% gain or until he had held them for two years.

In analyzing companies that were selling below net asset value in 1932, 1933, 1938 and 1939, Graham concluded that "stocks selling below working capital and showing a fair record of earning and dividends are likely to be 'bargain' issues and are likely to turn out to be unusally satisfactory purchases".

A research done by the State University of New York has shown that from the period of 1970 to 1983, an investor could have earned an average return of 29.4% by purchasing stocks that fulfilled Graham's requirement and holding them for one year.

Screening for Graham NCAV Stocks

Finding stocks meeting the Graham NCAV requirements require some digging. It is a time consuming and yet simple and rewarding process. There are no tools that are available on the web that can be used to screen for NCAV stocks. I have created a simple spreadsheet that I use to screen for NCAV stocks, you can download it here.

The criteria that I use to screen for NCAV stocks are as follows:

1) Net current asset value per share must be less than 66.7% of the current share price.

2) Must have positive earnings for the trailing 12 months.

3) Total shareholder's equity must be greater than total of current liabilities and long-term debt.

4) Must have positive operating cash flow over the last 12 months.

5) Capitalization ratio less than 0.1

6) Total liabilities must not be more than 50% of total assets (Debt ratio <0.5)

7) Interest coverage ratio must be more than 2.

Do note that not all companies that passed the above criteria are worthy investment candidates, it is important to do your due diligence check and limit your risk in individual stocks.