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Winning with the Net Current Asset Value Approach to Stocks

September 04, 2013 | About:
Not too long ago my Amazon (AMZN) suggestions page recommended a book called "The Net Current Asset Approach to Stock Investing." I was intrigued as I have been using net current asset value as a way to select stocks for decades now and apart from the occasional mention in a book or academic study, it is rarely talked about. The book was written by an investment adviser from Saint Louis by the name of Victor Wendl. I have not met Mr. Wendl as of yet but after reading his impressive book that is a condition I intend to remedy soon.

In the book the author has undertaken a rigorous study of the results of buying stocks trading at 75% of net current assets or less. This approach simply takes the current assets of a company, things that can be turned into cash relatively quickly, and subtracts all liabilities. Fixed assets such as buildings, equipment and machinery are not included in the calculation. Neither are intangible assets like good will, patents or brands. The resulting number is net current assets, or NCA, of the company. If one can purchase shares when the market capitalization of the company is less than the NCA value history has shown this to be a profitable venture.

The method was developed by Benjamin Graham back in the 1930s and has been used by a handful of true deep- value investors in the 90-plus years since then to rack up some pretty impressive gains in individual securities. There have been several studies to document the fact, and I can tell you from personal experience that the net returns on stocks I have purchased at a discount to NCA over almost three decades have been more than satisfactory.

Wendl did a thorough study of the returns available from buying stocks at a discount to NCA. He used the S&P Compustat database and examined all stocks listed on the NYSE, AMEX and Nasdaq markets, including all the ones that have disappeared via bankruptcy or takeover thought the years. He looked at the years of 1950 to 2009, a 60-year data set that covers some wildly changing market conditions. The minimum market capitalization he used was $25 million since smaller stocks are very illiquid. I suspect this hurts the overall returns, as some of most successful NCA stocks traded for less than that amount over 30 years. He rebalanced the portfolios just once a year. The results are impressive to say the least.

His portfolios spread the money around equally among stocks trading at 75% or less of NCA value each year with a maximum allocation of 10% to any one stock. If there were not 10 stocks meeting the criteria the balance was in Treasury bills. Over the 60-year period of time the portfolio compounded at 19.89% annually, almost double the 10.67% return of the stock market as measured by the S&P 500 index. To put that in dollar terms, $1 invested in the index results in a not-too-shabby $586.22. One dollar invested in the net current asset approach yields $138,161, a slight improvement over the market to say the least. Incredibly, over the one-year holding period, more than 70% of the stocks moved higher.

The book goes on to examine investing in these stocks from several other aspects, but I'll let you discover those on your own. One final piece of information might be more relevant to helping you understand just how well this approach can work for you. The period between 2000 and 2009 was one of the worst periods in stock market history with investors in the index losing an average of 1.19%. Investors using the NCA approach saw their holdings compound by 27.04% over the same period of time. Instead of a net loss, each $1 invested grew to $14.49 during what many have called the lost decade for the stock market.

These are fantastic numbers that might lead you to wonder why everyone is not doing this with their money. The large institutions might want to but they simply cannot. Most of the stocks are just too small in size for a multibillion dollar fund to invest in these issues. If you take one of the net-net stocks I hold now, Gencor (GENC), a $1 billion fund, wishing to take a 2% position in the stock would be investing $20 million and owning more than 25% of the company. They are simply shut out of the net current asset strategy by size and liquidity issues.

Most individual investors simply do not have the psychological makeup to implement this approach. You are buying stocks that are down in price, usually substantially so. They are not the popular darling stocks everyone likes to talk about, and many times they will be companies you have never heard of before. It is not a trading-oriented approach, and there is very little buying and selling activity over the course of a year. There is no “action” and the only excitement is from seeing your account balance grow over time. You are going to be away from the herd with no social or peer validation of the strategy, and most of your colleagues and friends will think you are nuts when you mention that you purchased shares of an Italian furniture company and a chain of music stores below liquidation value. Most people simply cannot execute this long-term patient disciplined approach to investing.

Buying stocks at a discount to net current asset value works and has for an extended period of time. It is worth your time to learn more about this investing strategy and put it to work for yourself.

About the author:

Tim Melvin
Tim Melvin is a value investor, money manager and writer. He has spent the last 27 years as in the financial services and investment industry as a broker, adviser and portfolio manager. He has also written and lectured extensively on the markets with his work appearing on RealMoney.com, DailySpecualtion.com, Benzinga.com as well as several print publication including Active Trader and the Wall Street Digest.

Visit Tim Melvin's Website


Rating: 2.7/5 (6 votes)

Comments

xtddd
Xtddd - 11 months ago
excellent article. this method is difficult to practice because it goes against human nature when buying out of favor stocks.
Quickbeam
Quickbeam - 11 months ago


Hi thanks for the article. I wrote my master thesis on net nets in the US. I used the strict graham cut off point of 2/3 of working capital. I also opted not to invest if there were no net nets around. This showed a CAGR of around 23% over 15 years +. The Thesis is available under my name floris oliemans. Obviously there are limitations in terms of liquidity, but other studies similar to mine has also shown CAGRS of 20%+, as the mentioned study highlights. I haven't found a quantative strategy that I can logically understand that has produced better results than net nets. Investing in net nets is still alive and well, but I believe one has to look beyond the US and go global to be able to build a diversified portfolio. The current number of net nets in the us is low and the quality of the names is even worse (China RTO, Blown biotechs). I guess its just a sign of how expensive the US market is. Globabl markets overall are expensive, but if you look under enough rocks you'll still be able to find some. I have a portfolio of approx ~ 17 net nets.

Reg

Floris
Tim Melvin
Tim Melvin - 11 months ago
Glad you guys liked the article.

Very interesting @Quickbeam

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