Seeking Alpha
Long/short equity, special situations, event-driven, activist investor
Profile| Send Message|
( followers)  

Summary

  • Contrary to popular belief, there are still quite a few stocks that trade below Benjamin Graham's "Net Current Asset Value".
  • Even if they trade at "NCAV" or slightly above, they are still very undervalued.
  • We backtest a screening strategy to see how the hundred most undervalued stocks by asset value would have performed over the past four years.

The purpose of this article is to show how applying Graham's "net net" formula to filter a list of stocks will always perform exceptionally well if a large enough sample of stocks is taken.

As a reminder, Graham's "net net" formula is calculated as Net Current Asset Value divided by number of shares outstanding. Net Current Asset Value (NCAV) is simply current assets minus total liabilities. If the NCAV per share is less than the share price, one could in theory buy all the firm's shares and sell its assets for a profit. Though there are very few companies that do trade beneath net current asset value, it is not an "extreme" rarity as some people say. The truth is that most of them are headed nowhere, which is the reason for their cheap valuation. Some also, such as insurance companies, are not interesting from that viewpoint as they have no tangible assets to sell and therefore do not trade in relation to asset value. However, regardless of whether they are trading below or just above net current asset value, they are all extremely undervalued. A big enough selection of such stocks would likely have a superior performance, given that they can hardly trade at lower prices. The date 31st of March 2010 is chosen as the start date for this backtest and the end date is the 16th of April 2014:

We choose the Russell 3000 which contains 99% of the US equity market for our selection and download the following data for these 3000 companies on the 31st March 2010: Current Assets, Total Liabilities, Total Shares outstanding, Price.

Figure 1: Data for the thirteen most undervalued companies

We calculate the NCAV per share and then the difference between the NCAV per share and the price on the 31st of March 2010. There are less than 10 companies that do trade below NCAV per share and most of them have declining revenues even if they have an obviously very safe financial position with ample cash reserves for little debt. Following that we rank the 3000 companies by order of the biggest difference between NCAV/share and price. We select the top 100 companies for which that difference is the largest and then calculate the individual simple returns for these companies from the 31st march 2010 to today. We get an average annual return of 23.03% for the top 100 companies compared to a 12.47% return for the Russell 3000 index.

Figure 2: Returns for the thirteen most undervalued companies

Figure 3: Value Portfolio vs. Russell 3000 over the past four years

Top Three performers:

1. Akorn Inc. (NASDAQ:AKRX): 1312.42% (93.86% per annum)

2. Acadia Pharmaceuticals (NASDAQ:ACAD): 1115.89% (86.73% per annum)

3. CalAmp Corp. (NASDAQ:CAMP): 741.99% (70.34% per annum)

Our portfolio returned an average of 23% per year, almost double that of the Russell 3000 which returned an average of only 12.47% during the same period. This shows that a big enough selection of stocks which are undervalued relatively to assets will probably beat the market by a significant margin. These stocks may stay cheap for a long time but they are so undervalued that they will probably not fall significantly. At the worst they will continue to be ignored and trade at the same valuation. Those that are recognized by the market for what they are worth will probably do exceptionally well.

Source: Backtesting A Value Strategy