It is widely recognized that value strategies - those that invest in stocks with low market values relative to measures of their fundamentals (e.g. low prices relative to earnings, dividends, book assets and cash flows) - tend to show higher returns. I
n this paper we focus on the early value metric devised and employed by Benjamin Graham - net current asset value to market value (NCAV/MV) - to see if it is still useful in the modern context. Examining stocks listed on the London Stock Exchange for the period 1981 to 2005 we observe that those with an NCAV/MV greater than 1.5 display significantly positive market-adjusted returns (annualized return up to 19.7% per year) over five holding years. We allow for the possibility that the phenomenon being observed is due to the additional return experienced on smaller companies (the "size effect") and still find an NCAV/MV premium. The profitability of this NCAV/MV strategy in the UK cannot be explained using Capital Asset Pricing Model (CAPM). Further, Fama and French's three-factor model (FF3M) can not explain the abnormal return of the NCAV/MV strategy. These premiums might be due to irrational pricing.
Data Source:
The dataset covers all companies listed on the London Stock Exchange from January 1980 to December 2005. The two databases they use to collect data are the London Share Price Database and Datastream (annual accounting data).
Foreign and financial companies, as well as companies with more than one class of ordinary share are excluded.
Their full sample consists of 2438 companies and contains 90% of the universe in the London Share Price Database.
Data Specification:
For this strategy, you follow Ben Graham's classic "net/net" strategy. (See Clyde's site http://stocksbelowncav.blogspot.com/ for more information and real-time analysis). The strategy is simple: buy all the companies which are selling for less than 2/3 of their estimated Net Current Asset Value (Current Assets minus short and long term debt divided by shares outstanding).
In this paper specifically, the authors buy all companies selling for less than 2/3 their Net Current Asset Value in July (to allow for all past annual accounting data to be up to date). Once the portfolios are formed, they test the results for 1, 2, 3, 4, and 5 year holding periods.
Pretty simple.
Results:
Table 2 outlines the raw returns to Graham's timeless strategy. Using equal weights, the Net Current Asset Value portfolio has average buy and hold returns as follows (vs equally weighted market index return):
1yr: 31.2% vs 20.5%
2yr: 75.1% vs 45.9%
3yr: 126.3% vs 73.3%
4yr: 191.6% vs 105%
5yr: 254.0% vs 137.2%
There is no denying that Ben Graham has struck again and is still smiling in his grave (he has been smiling a long time now due to Warren Buffett's success)
Investment Strategy:
Implementing this strategy on the US equity is very simple. Any number of services (yahoo finance , MSN, bloomberg, etc) provide the necessary accounting data to calculate the universe of stocks selling for less than 2/3 of Net Current Asset Value.
Implementation Issues and Remarks:
There are a few snags with Ben Graham's strategy...
The first issue is in the diversification of the portfolio. In this paper, for the first 10 or so years the portfolio holds an average of 20-30 stocks; however, from 1994 to 2000 the portfolio consists of 4-11 stocks...that is VERY risky business. This strategy seems to go in waves; I know from personal trading experience that this number (in the US) ballooned in 2002-2004 from the NASDAQ blowup to around 40, but has since reverted back to single digits. Overall: if you got the cajones to hold less than 10 stocks--go for it--but expect a wild ride.
The second concern with this strategy is that it is simply loading up on 'small firm risk.' Table 7 shows that much of the returns from this Ben Graham strategy can be recouped by simply investing in the lowest decile of market capitalization. You won't score as big investing in small caps as you will investing in the net nets, but you will have a much larger breadth of stocks to invest in (increase diversification).
The final matter to ponder is the scalability of this strategy. Using Ben Graham's technique typically limits the investor to companies that are less than $50mm. If you are managing more than a couple of million bucks, the Ben Graham strategy, on average, is not going to be feasible.
Now all that said...
Why does this strategy still kick ass? Well, put simply--because Ben Graham invented it and he is the God of value-investing and all that he does is holy...
In all seriousness, this strategy is an opportunistic strategy and comes in waves. When markets are hot, it is unlikely the Net net strategy will produce much value; however, when markets get burnt, as they did in 2002-2003, the net net strategy shows amazing promise with more and bigger companies to choose from, thus making the net net strategy cost efficient, scalable, and profitable.
If the net net strategy were implementable in all markets and all conditions I would give it a 10/10, but because it is limited in scope and only implementable at certain times, this wonderful little strategy gets a rating of 7/10--still good, but not outstanding.
Source: Empirical Finance Research Blog
n this paper we focus on the early value metric devised and employed by Benjamin Graham - net current asset value to market value (NCAV/MV) - to see if it is still useful in the modern context. Examining stocks listed on the London Stock Exchange for the period 1981 to 2005 we observe that those with an NCAV/MV greater than 1.5 display significantly positive market-adjusted returns (annualized return up to 19.7% per year) over five holding years. We allow for the possibility that the phenomenon being observed is due to the additional return experienced on smaller companies (the "size effect") and still find an NCAV/MV premium. The profitability of this NCAV/MV strategy in the UK cannot be explained using Capital Asset Pricing Model (CAPM). Further, Fama and French's three-factor model (FF3M) can not explain the abnormal return of the NCAV/MV strategy. These premiums might be due to irrational pricing.
Data Source:
The dataset covers all companies listed on the London Stock Exchange from January 1980 to December 2005. The two databases they use to collect data are the London Share Price Database and Datastream (annual accounting data).
Foreign and financial companies, as well as companies with more than one class of ordinary share are excluded.
Their full sample consists of 2438 companies and contains 90% of the universe in the London Share Price Database.
Data Specification:
For this strategy, you follow Ben Graham's classic "net/net" strategy. (See Clyde's site http://stocksbelowncav.blogspot.com/ for more information and real-time analysis). The strategy is simple: buy all the companies which are selling for less than 2/3 of their estimated Net Current Asset Value (Current Assets minus short and long term debt divided by shares outstanding).
In this paper specifically, the authors buy all companies selling for less than 2/3 their Net Current Asset Value in July (to allow for all past annual accounting data to be up to date). Once the portfolios are formed, they test the results for 1, 2, 3, 4, and 5 year holding periods.
Pretty simple.
Results:
Table 2 outlines the raw returns to Graham's timeless strategy. Using equal weights, the Net Current Asset Value portfolio has average buy and hold returns as follows (vs equally weighted market index return):
1yr: 31.2% vs 20.5%
2yr: 75.1% vs 45.9%
3yr: 126.3% vs 73.3%
4yr: 191.6% vs 105%
5yr: 254.0% vs 137.2%
There is no denying that Ben Graham has struck again and is still smiling in his grave (he has been smiling a long time now due to Warren Buffett's success)
Investment Strategy:
Implementing this strategy on the US equity is very simple. Any number of services (yahoo finance , MSN, bloomberg, etc) provide the necessary accounting data to calculate the universe of stocks selling for less than 2/3 of Net Current Asset Value.
Implementation Issues and Remarks:
There are a few snags with Ben Graham's strategy...
The first issue is in the diversification of the portfolio. In this paper, for the first 10 or so years the portfolio holds an average of 20-30 stocks; however, from 1994 to 2000 the portfolio consists of 4-11 stocks...that is VERY risky business. This strategy seems to go in waves; I know from personal trading experience that this number (in the US) ballooned in 2002-2004 from the NASDAQ blowup to around 40, but has since reverted back to single digits. Overall: if you got the cajones to hold less than 10 stocks--go for it--but expect a wild ride.
The second concern with this strategy is that it is simply loading up on 'small firm risk.' Table 7 shows that much of the returns from this Ben Graham strategy can be recouped by simply investing in the lowest decile of market capitalization. You won't score as big investing in small caps as you will investing in the net nets, but you will have a much larger breadth of stocks to invest in (increase diversification).
The final matter to ponder is the scalability of this strategy. Using Ben Graham's technique typically limits the investor to companies that are less than $50mm. If you are managing more than a couple of million bucks, the Ben Graham strategy, on average, is not going to be feasible.
Now all that said...
Why does this strategy still kick ass? Well, put simply--because Ben Graham invented it and he is the God of value-investing and all that he does is holy...
In all seriousness, this strategy is an opportunistic strategy and comes in waves. When markets are hot, it is unlikely the Net net strategy will produce much value; however, when markets get burnt, as they did in 2002-2003, the net net strategy shows amazing promise with more and bigger companies to choose from, thus making the net net strategy cost efficient, scalable, and profitable.
If the net net strategy were implementable in all markets and all conditions I would give it a 10/10, but because it is limited in scope and only implementable at certain times, this wonderful little strategy gets a rating of 7/10--still good, but not outstanding.
Source: Empirical Finance Research Blog
