In The Intelligent Investor, Benjamin Graham discussed the methods he used in his investment firm Graham_Newman. One is them is what he called Net-Current-Asset (Or “Bargain”) issues. He wrote”
The idea here was to acquire as many issues as possible at a cost for each of less than their book value in terms of net-cirrent-assets alone – i.e., giving no value to the plant account and other assets. Our purchases were made typically at two-thirds or less of such stripped-down asset value. In most years we carried a wide diversification here – at least 100 different issues.
Graham’s “net current asset value” approach, apparently works very well. One research study, covering the years 1970 through 1983 showed that portfolios picked at the beginning of each year, and held for one year, returned 29.4 percent, on average, over the 13-year period, compared to 11.5 percent for the S&P 500 Index. Other studies of Graham’s strategy produced similar results.
They were not around much for modern value investors. But the recent drastic decline of the stock market has created these opportunities. In response of this, GuruFocus has created Graham Bargain Screener for value investors to get into these opportunities.
Ben Graham loved these types of situations, defining the net-net value as:
Cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) - total liabilities
Graham looked for companies whose market values were less than two-thirds of that net-net value.
The risk in investing these companies is that most of them are not well run, and may be losing money continuously. To reduce the risk, we also require these companies have postive operating cash flow, in this way, the companies will probably be able to maintain their operations without burning its cash. We also requires the companies not have meaningful debt.
With this in mind, GuruFocus has created a Graham Net Current Asset Value screener to filter out the companies that meets the net-net value criteria. The rules are:
The stock prices are less than the net current asset value of the companies – Benjamin Graham
During the past 12 months, the companies generated postive operating cashflow.
The company has not meaning debt compared its cash position.
According to Benjamin Graham, some of these companies may well become insolvent as economic conditions get worse, it is important to hold a diversified group of them.
The is the link for Graham NCAV Bargain Screener.
Example: PRLS - Peerless Systems Corp. ($1.92)
Here we like to discuss a company which comes out our list, Peerless Systems Corp (PRLS). Peerless Systems Corporation is a provider of software-based embedded imaging and networking systems to original equipment manufacturers of digital document products.
The company is in technology sector, which most of value investors would avoid. However, if you look at the balance sheet and the market cap of the company, what the company does becomes irrelevant. The company’s balance sheet is extremely simple. It has $55 million cash, no meaningful PPE, no inventory, more importantly, no debt besides $7.8 million of account payable. Therefore, the company’s equity is $44 million, which is mostly cash. On Nov. 21, the company shares closed at $1.92, which 18 million shares outstanding, the company has a market cap of $35 million, which is less than 80% of the net cash available in the company balance sheet as of July, 31, 2008 .
|Balance Sheet||July 31, 2008|
|Cash and Equiv||55.13|
|Short Term Inv.||--|
|Other Current Assets||0.71|
|Total Current Assets||56.90|
|Other Long-Term Assets||0.20|
|Current Portion of Long-Term Debt||--|
|Other Current Liab.||1.44|
|Total Current Liabilities||9.26|
|Other Long-Term Liab.||3.66|
What is the risk for PRLS to run out of cash? While, during the last 12 months, the company had about $6 million of operating cash flow. Therefore, it is more likely for the company to increase their cash positions over the coming quarters than to deplete it.
This is a real dollar bill for 80 cents, no assumptions for future earning, no discount cash flow. Do you want it now?
As pointed by Ben Graham, it is important to buy a basket of net current asset bargains for this investing strategy. We have scanned our database, and found moer than 40 companies that are traded at a discount of net current asset value, and have postive operating cash flow. The screener is called Graham NCAV Bargain Screener.
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