http://www.tradingtips.com/Value investing has an appealing logic to many investors. The idea is simple. Value investing generally involves searching for stock trading tips at discounts to their fair value. These stocks can be bought and held until they trade at or above their fair value.
These ideas were first put forth by Benjamin Graham, a business school professor who counted Warren Buffett among his students. Graham is widely considered to be the father of value investing and he wrote widely on the topic. His work includes descriptions of strategies that he found to be successful.
Graham developed and tested the net current asset value (NCAV) approach between 1930 and 1932. He later reported that the average return, over a 30-year period, on diversified portfolios of NCAV stocks was about 20%. An independent study showed that from 1970 to 1983, the strategy gained an average of 29.4% a year.
What Is NCAV?
Graham defined NCAV in the 1934 edition of Security Analysis, the book he cowrote with David Dodd. He said NCAV is equal to “current assets alone, minus all liabilities and claims ahead of the issue.” In accounting terms this is current assets minus the sum of total liabilities and preferred stock.
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Current assets are cash and cash equivalents, receivables, and inventories. They are already cash or are convertible into cash within a relatively short period of time (usually less than a year). Net current assets exclude intangible assets along with the fixed and miscellaneous assets of a firm.
Some readers may see a similarity between NCAV and working capital which is defined as current assets minus current liabilities. The difference is that NCAV deducts total liabilities (current and long-term) from current assets.
Compared to book value, the NCAV method is a more rigorous standard. Book value can include intangible assets, which can be overstated in value. Book value includes land, property and equipment which can take considerable time to convert to cash.
In their book, Graham and Dodd pointed out that when stocks trade below the company’s NCAV they are, most likely, trading below the company’s liquidating value. This means that it is reasonable to assume that most companies can be sold off for at least the value of these assets.
They also noted there was a margin of safety in the company’s remaining assets, fixed assets like plant, property and equipment. These assets could, in time, be sold to offset any loss incurred when converting the current assets into cash.
Graham and Dodd created an investment strategy based on NCAV. When they found companies trading well below their liquidating values, they bought them.
Screening on NCAV
In the 1949 edition of his book, “The Intelligent Investor,” Graham explained exactly how to screen for buy candidates. He wrote, “…if a common stock can be bought at no more than two-thirds of the working-capital alone—disregarding all other assets—and if the earnings record and prospects are reasonably satisfactory, there is strong reason to believe that the investor is getting substantially more than his money’s worth.”
To find a reasonably satisfactory earnings record, we required companies to have positive earnings per share from continuing operations for the past 12 months.
Earnings can hide operational difficulties since there can be accounting assumptions that generate earnings for some companies. To minimize this risk, we required that companies also have positive operating cash flow over the last 12 months. Cash from operations is defined as revenues less all operating expenses.
Graham also believed low debt levels would help these companies survive. Therefore, we screened for companies that have total-liabilities-to-total-assets ratio below 50%. This confirmed companies have more assets than liabilities.
We then screened for low prices, less than $2 a share. However, these stocks can be illiquid with low trading volume. Despite the risks, this can be a useful approach, again, in the long run. As Graham wrote in the 1973 edition of “The Intelligent Investor”:
“It always seemed, and still seems, ridiculously simple to say that if one can acquire a diversified group of common stocks at a price less than the applicable net current assets alone—after deducting all prior claims, and counting as zero the fixed and other assets—the results should be quite satisfactory.”
Current NCAV Buy Candidates
These stocks can carry risks and to minimize the risks Graham suggested the need to follow this strategy over the long term and to own all companies that offer buy signals. Just three companies passed our rigorous screen.
Appliance Recycling Centers of America, Inc. (Nasdaq: ARCI) sells and recycles household appliances through a chain of company-owned retail stores under the ApplianceSmart name. The company operates in two segments, Retail and Recycling. Its stores offer new appliances; affordable value-priced, niche offerings, such as close-outs, factory overruns, and discontinued models, as well as special-buy appliances.
The company operates 18 ApplianceSmart stores. It also provides turnkey appliance recycling and replacement services for electric utilities and other sponsors of energy efficiency programs. This is a low priced and risky stock.
Impreso, Inc. (Other OTC: ZCOM) manufactures and distributes various paper and film products for commercial and home use in the United States and internationally. Its products include engineering rolls, wide format ink jet media, desk top ink jet media, computer paper, jumbo laser rolls, laser cut sheets, thermal fax paper, copy paper, POS, add rolls, ribbons, cleaning cards, and laser and inkjet cartridges, as well as labels, tags, and tickets.
The company also produces custom private label bottled water; and operates an online web reference directory. It manufactures and distributes its products under the Alliance label, Impreso label, OEM brands, and other private labels. Impreso, Inc. markets its products to dealers and other resellers.
The stock’s long term downtrend can be seen in the chart below.
Rock Ridge Resources, Inc. (Other OTC: RRRI) engages in the oil and gas factoring activities. The company is also involved in the investment, exploration, and production of oil and gas; and provision of alcohol-drug treatment services.
In addition, it engages in the commercial and residential real estate investment and development activities. This is a very low priced stock that carries a great deal of risk.
A profit taking order could be used to capture a gain if this stock moves up.
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