Benjamin Graham's Net Current Asset Value Strategy

Benjamin Graham, the father of value investing, had a strategy to identify stocks with great value. (See my review of his classic book, The Intelligent Investor, here). Graham's net current asset value (NCAV), according to one published study, returned 29.4% annually from 1970 to 1983 if stock picking was done at the beginning of each year (and each stock held for a one-year period). This compares to 11.5% for the S&P 500 Index.

The Basics

Essentially, the strategy seeks to find stocks that trade below their calculated value, but how Graham defines "value" might differ from the typical definition. Graham looks at book value based only on current assets; that is, he ignores long-term assets, but includes long-term debt. In other words, the net current asset value is total liabilities subtracted from current assets (for how to break down a balance sheet, see this article by Richard Loth).

The strategy calls to purchase shares of stocks that are currently trading at 2/3 or less of their NCAV. Most companies have a negative NCAV, so this criteria really limits what companies will come through to a small (sometimes zero) number. Graham is really looking for the deep discounts, and then seeks to sell it when the share price rises up to its NCAV. He also posits that a company whose current assets are 1/3 greater than its total liabilities is financially sound. Unfortunately, there is no website tool that I know of that screens for NCAV stocks, and investors must come up with their own screens to determine them.

Graham's NCAV often results in tiny microcap companies that trade for very small amounts. Thus, there is certainly increased risk involved. I always avoid penny stocks, and micocap companies (typically defined as those with a market caps less than $250 million) need to be evaluated and monitored very closely as they can be disastrous. So, while this strategy looks for deep discounts, to me, it seems like a high-risk, high-reward strategy on first glance since it typically results in small little-known companies. Having said that, Graham himself even acknowledges that his strategy would yield several companies that end up failing, so he recommended that investors buy a large number of stocks to diversify risk.

How do we find the stocks that meet Graham's criteria?

Using the stock screen feature at Charles Schwab, I used the following criteria: 

1.) Stock Price - Really cheap stocks usually indicate the company is in trouble and lead to a huge increase in risk. Thus, I set a minimum price of $3.  
2.) Price/Cash Flow (TTM) - This is a profitability measure. To eliminate high-risk companies and stocks likely to meet Graham's criteria, look for positive cash flow. I set a P/CF minimum of 0.1.  
3.) Price/Sales (TTM) - A low P/S ratio is a typical trait of NCAV. I set a maximum P/S ratio of 0.3.  
4.) Price/Book (MRQ) - NCAV stocks will have a small P/B ratio. I set it to <1.  
5.) Debt/Equity - Low debt is key to meet NCAV criteria. I set a maximum of 0.1 D/E ratio. 
6.) Market cap - To help offset some risk, I only wanted to view companies with a market cap of at least $100M (still considered microcap).

    This yields only 7 stocks (HVT, IMN, KBALB, PSUN, PCCC, TUES, and VOL). To determine if they meet Graham's criteria, there is a convenient calculator located here. (Update 9/21/2009: Unfortunately, this calculator is no longer free. Instead it is part of the $14.99 Stock Research Pro Valuation Software that is available for download here. I recommend performing the calculations on your own as they're not very difficult.)

    Go to Yahoo! Finance or Google Finance and look at Financials -> Balance Sheet -> Quarterly Data. Look up Current Assets, Total Liabilities, and Total Common Shares Outstanding. Enter the data in the calculator and voila! If a company is both healthy and bargain, it meets the criteria. Unfortunately, none of the 7 above are both healthy and bargain. That criteria certainly is stringent, isn't it?

    So, I set to make my criteria a little less strict. I reduced the market cap to $20 million, set the minimum stock price to 2, and eliminated the Price/Cash Flow using Google Finance's stock screener (P/CF isn't even an option with Google Finance). You can see the criteria by clicking this link.

    This resulted in 12 companies: ACAT, BBW, FRD, FFEX, GAI, KCP, PSUN, RCMT, SCVL, SLI, TONE, and XRTX. Of these, only two are both healthy and bargain. The lucky two? RCM Technologies, Inc. (RCMT) and Global-Tech Advanced Innovations Inc (GAI). A couple others - ACAT and FRD - just barely miss being at Graham value level. ACAT would have met the criteria just a month ago, but it is up a whopping 44% since then!

    As you can see, this is a very limited group, and if your screen results in no matches, just try again later. When stocks have been battered, there will be many more to choose from. I'm sure if I ran this screen in March or last November, there would have been a lot more results.

    You can check out the following blog that chronicles stocks below NCAV:


    As of right now, I can't really recommend this strategy. It certainly isn't for everybody and results in speculative plays. If, however, you have a portion of your portfolio (hopefully, it's small, as in 5-10%) that is dedicated to speculative micro-caps that you can live with going to zero, then this method is certainly a great one to utilize. And to diversify risk, choosing several companies as opposed to one would also be preferable. But these companies need to be monitored closely, so only invest if you have both the time to dedicate as well as the knowledge base to know when to get in and out. In the end, this strategy identifies companies that are in seemingly strong financial positions at a great price - but can lead to risky companies.

    Update 10/6/10:  How are the two stocks mentioned above doing over a year later?  Well, RCMT is up to 5.00, a 100% gain!  GAI, on the other hand, is down to 8.49, for a decrease of 1.6%.  This is too small of a sample size to make any conclusions, but I still find it interesting.   RCMT increased from 3.5 to 4.93 in a day (June 4, 2010) after an unsuccessful takeover bid by CDI Corp for $5.20/share.  (RCMT rejected the offer.)
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