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Finally. Proof that Ben Graham Knew How to Time the Market.

September 23, 2013
Previously, I quickly went through a way to check the stock market value using net nets.

A good question came up in the comment section.

What is the average number of net nets in a bull market?

To answer this question, I need to go back in time.

Time the Market like Ben Graham

Back in 1986, Henry R. Oppenheimer wrote a paper titled Ben Graham’s Net Current Asset Values: A Performance Update. The paper studied the number of net nets that existed from 1970 to 1982 and its performance. The main objective of that paper was to see how NCAV stocks performed.

The stocks and performance of the results from the paper were based on stocks that met the core Graham criteria of being priced below 2/3 of NCAV.

Historical performance isn’t what I’m interested in because I know that NCAV stocks beat the market, but I have included it to provide a bigger picture. What I do want to focus on is the number of net nets in any given year.

Ben Graham’s Net Current Asset Values: A Performance Update

Performance as calculated by Oppenheimer | Enlarge

The performance table is hard to understand at a glance so here’s a better view.

A Better View of the Chart | Credit: http://somrh.blogspot.com/

Look at the NYSE and AMEX columns first.

Under the NYSE totals, 1973, 1974 and 1975 were clearly the cheapest years. A new revelation is that looking at the NYSE stocks makes for a better indicator. If the larger stocks are suddenly becoming net nets and the number is increasing, that’s a clear sign of market cheapness. There are always going to be cheap OTC and small caps each year, but for large caps to come down to such levels mean that it is time to jump in.

Under AMEX and OTC, from 1973 to 1979, it’s difficult to figure out which year was cheap. The sum of NYSE and AMEX provides mixed results making some years hard to figure out.

Here’s a better chart to get a sense of the number of net nets.

Total number of net nets with and without OTC stocks

For extra reference, here’s information on the USA recessions between 1969 to 2009. Compare the recession time periods with when the market was cheap according to Graham.

USA Recessions Between 1969 – 2009

The 1973 to 1975 market is the only one that syncs up. What this goes to show is that a recession does not equate to a cheap market because the stock market may not have crashed. Also it shows how resilient the market is.

For a market to be cheap, there has to be a stock market crash, and that’s what happened during 1973 – 1975. The Vietnam war and 1973 oil crisis only heightened the severity.

Graham Created a Market Timing System Whether he Knew it or Not

I wanted to replicate what Oppenheimer did with recent data. The results I’m showing you isn’t going to be as scientifically or systematically accurate as Oppenheimer. However, you should be able to see what I’m trying to prove.

The total stocks are based on meeting 2/3 of NCAV, but the return calculations differ because I added the following criteria.

  • 5% slippage
  • 1.5% carry cost
  • no volume minimums
The number of nets nets in this table include miners and utilities which were excluded in my initial post a couple of days back. The pink highlighted rows denotes recessionary years. To reduce time, the number of stocks were counted based on the start of the year (Jan 1).

Total Net Nets 1999 – Sept 2013 | Recession Year Highlighted Pink

Chart of Years the Stock Market was Cheap

The clear signal is that 2001 – 2003 and 2009 were the best years to be buying hoarding.

It was also the scariest.

You may have noticed that the NYSE and AMEX totals are not included in the 1999 – 2013 table. As I was going through the data, I realized that there were literally zero stocks from the NYSE that met the 2/3 NCAV criteria, even during the cheapest years.

What this says is that the information and tech we are surrounded by helps the market to be more efficient than it used to.

So the next best thing I can do is to count the number of companies trading for less than NCAV.

Not 2/3 of NCAV, just< NCAV.

Remember that this 6 hour study I did isn’t going to win a Noble prize. It’s to show that Graham, whether he intended it to be used like this or not, could time the market.

No. of Stocks Trading< NCAV

I broke down 2008 into quarters because the crash took place in September so I wanted to see whether the numbers reflected that.

NYSE stocks didn’t show anything different until 2009, while AMEX stocks shows a near double from 2008 Q3 to 2008 Q4.

What is the Average Number of Net Nets in a Bull Market?

As it turns out, the initial question is irrelevant. The average number doesn’t matter. The key point is to look for the total count in relation to the previous years.

Imagine this was 2009 all over again, panic is everywhere. From 2005 to 2008, the number of net nets were in the single digits. Now the number of net nets has doubled or tripled.

That is the sign that Graham would have waited for.

Warren Buffett: Stocks now ‘more or less fairly priced’

Buffett went on the record saying that stocks are now “fairly priced”. He was careful in choosing those words making sure not to say “expensive” and cause a huge ruckus.

Superinvestor Seth Klarman has also said that he will be returning money to investors at the end of the year for lack of investment opportunities.

Both gurus are saying this because they can’t find anything worth buying in bulk. For you and me, it’s easier because we can play with the smaller companies. Just the other day, a popular net net around the value blogosphere (LAKE) shot up 30% after excellent earnings.

By taking the Graham approach, there is always value to be found. Just harder work, but it’s there if you look hard enough.

According to the data I’ve shown you, the market is indeed “more or less fairly priced”.

Right now, even Graham is working up a sweat to find some deals, but boy, did he create an awesome way for value investors to time the market.

Click here for [ur=http://www.gurufocus.com/grahamncav.php]GuruFocus list of net-net across the global market.[/url]

About the author:

Jae Jun
Founder of Old School Value (http://www.oldschoolvalue.com) dedicated to offering the most complete and detailed stock valuation and analysis spreadsheet. Investing made easy by importing 10 years of financials and 5 quarterly statements directly to excel for your analysis needs. Save time, make smarter decisions and make more money.

Visit Jae Jun's Website


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