I have long been fascinated by Benjamin Graham's mechanical investment in NCAV (Net Current Asset Value) stocks. Especially, with many studies showing that high returns are very possible.
Having read Graham's "Security Analysis" in the past, and recently having read "The Net Current Asset Value Approach to Stock Investing" by Wendl, I'm feeling pumped to personally try some net-net investing. I thought it might be fun to publicly create a portfolio, lay out some ground rules, and report back monthly.
Why monthly? I want readers to get a feel for the volatility that accompanies this strategy. It will likely be a gut-wrenching ride.
Let me get this out of the way upfront: I am not suggesting this strategy (or portfolio) for others. While studies suggest very pleasant returns (20+%) averaged over long periods, there is the aforementioned high volatility coupled with low liquidity. Also, some years this strategy will underperform the market, perhaps even sharply underperform. The trick will be to stick with it during such times.
What is an NCAV stock?
An NCAV stock is a stock which is trading below its Net Current Asset Value per share.
Net Current Asset Value per share is defined as (Total Current Assets - Total Liabilities - Preferred Stock) divided by Total Shares Outstanding.
Basically, the NCAV per share should tell us the company's liquid assets per share in excess of all other obligations. Believe it or not, some stocks trade below this amount, meaning they have a higher NCAV then stock price.
Why does this happen? The short answer: fear, and often with good reason. These are companies that investors perceive as circling the toilet, many have limped along for several years. Earnings are usually terrible, products outdated, revenue slipping, large customers leaving, etc.
These are not the best companies in the world, they are in fact amongst the worst. However, we are buying them for the value of their more liquid assets rather than their actual business. This of course with the assumption that the market will eventually recognize them at a minimum of at least the full NCAV price.
Advantages to the small investor.
- Due to the market caps involved & scarcity of NCAV stocks in general, it is difficult for large investors to use this strategy to move the needle. Good returns on a tiny fraction of a percent of their portfolios are simply not worth the effort.
- It is an entirely mechanical strategy. This eliminates much of the emotion that can cause an investor so many problems.
- NCAV stocks are fairly easy to screen for. Primarily, because most of the things an investor will need to look at are quantitative in nature rather than qualitative.
- And finally, It doesn't take a lot of time. A glance every quarter at the companies' balance sheets to make sure there are no substantial changes to NCAV and that's it.
The Ground Rules
For this portfolio, as it is a mechanical strategy, we must have our rules of engagement clearly spelled out before we begin. I have largely adopted Wendl's suggestions for basic construction.
- We will only purchase stocks trading at 75% of NCAV or below.
- All stocks must have a market cap greater than 10 million dollars at the time of purchase.
- Only stocks traded on major exchanges will be considered.
- No one stock will exceed 10% of the portfolio weight at the time of purchase. As more NCAV stocks present themselves throughout the year existing positions may be pared back to a 5% weight, or additional cash introduced into the portfolio to achieve the same end.
- We will sell all positions when their price is equal to their NCAV. This will doubtless lead to tears on occasion as a stock shoots well past NCAV shortly after we have sold it.
- At the end of a year, stocks still trading under NCAV will be retained. No stock will be held for more than two consecutive years.
These will be looked at in an attempt to avoid being burned. They are not hard rules here, and will be subjectively weighed, & occasionally ignored.
Few US-based NCAV stocks will meet all or even most qualitative considerations. This is particularly true with the current rich valuation level of the broader market. The stocks trading below NCAV right now in the US are mostly the dregs of the dregs, not the ample fare we might have had in previous years.
- P/E below 10. Wendl demonstrates that focusing on PEs below 10 improves results.
- Low share issuance. Some NCAV stocks issue massive amounts of shares to help keep afloat. I don't like ownership dilution.
- No Chinese stocks, due to fraud concerns.
- Low cash/liquid asset burn rate. We want to avoid having them eat up our opportunity aka their NCAV.
- Has real business operations. Many companies trading below NCAV are research companies with no products or revenue.
In no particular order here are the picks, and believe me it is slim picking right now. The below are simply the result of a quick screen coupled with a look at the qualitative factors. Many qualitative factors could not be completely satisfied.
As you can see, I haven't devoted much money to this enterprise. I need to be sure the strategy suits my mentality before committing more heavily.
Truthfully, I have also had difficulty locating decent NCAV stocks as well. This has forced me, as you will note, to leave a portion of the portfolio in cash for the time being. Hopefully, by next month's report, I will be 100% invested.
I'm excited to see how this goes and how it matches up against the broader market. As I mentioned, I am new to this style of investing, so let me know if I've made some grievous errors, or share any suggestions you may have in the comments. Cheers!
PS. I plan to make a competing public portfolio of stock picks inspired by the Buffettology book series in the near future. It should be more suitable & less volatile for most investors. Plus, it will also have the advantage of being more in my area of experience & expertise. So stay tuned.
Disclosure: I am/we are long MSN,RBCN,RELL,IOT,DSWL,WILC,AEY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.