1February Online Exclusive 2010
edition o “Security Analysis,” whichhe coauthored with David Dodd. Inthe book, (net) current asset value isdened as:“current assets alone, minus allliabilities and claims ahead o theissue.” The common denition o NCAV is:
NCAV = current assets – [total liabilities +preerred stock]
Current assets consist primarily o cash and cash equivalents, receiv-ables, and inventories. Basically, theseare assets that are already cash or areconvertible into cash within a rela-tively short period o time (usuallyless than a year). Net current assetsexclude not only the intangible assetsbut also the xed and miscellaneousassets. In addition, Graham believedthat preerred stock belongs on theliability side o the balance sheet,not as part o capital and surplus. In“Security Analysis,” preerred stock is dubbed “an imperect creditorshipposition” that is best placed on thebalance sheet alongside unded debt.Net current assets dier romworking capital in that workingcapital is current assets less currentliabilities, thereby ocusing only onthe current segments o the balance
Benjamin Graham’s Net CurrentAsset Value Approach
By Wayne A. Thorp, CFA
“From 1970 to 1983,an investor could haveearned an average return o 29.4% by purchasing stocksthat ulilled Graham’srequirement and holdingthem or one year.”
sheet. In contrast, NCAV deductstotal liabilities (current and long-term) rom current assets. However,Graham used the terms interchange-ably.Compared to book value, theNCAV method is a more rigorousstandard. Book value can includeintangible assets, many o which maybe impaired in some manner. Fur-thermore, book value includes land,property and equipment, which areignored altogether by NCAV. How-ever, over time, the on-the-book valueo such assets is more than likely notan accurate representation o theiractual worth.
NCAV & Market Value
In “Security Analysis,” theauthors note that net assetvalue, or book value, seem-ingly was o little importanceto investors looking at “indus-trial companies,” citing theact that stocks can sell at highmultiples or at mere ractionso book value. Investor rea-soning was that share prices,by and large, are driven by acompany’s earning power anddividend payments, which ingeneral have no close relation-ship to the asset value (ex-cluding utilities and nancial rms). Thereore, investors and speculatorsalike had, or the most part, come toignore asset value.Beginning in the 1930s, ollowingthe market crash o 1929, Grahamand Dodd noticed a large numbero stocks selling below their currentasset value, meaning that the shareprice o a company is less than theper share value o current assets.During this period, the low prices tonet asset values were primarily drivenby poor earnings, which in turndrove stock prices down. Perhaps notsurprisingly, according to Grahamand Dodd, the market greeted thesestocks with uncertainty and indi-
utside o Warren Buett,perhaps no other investor isas well-known as his mentor Benja-min Graham. Considered by most tobe the ather o value investing andoten credited as the creator o thestock analyst proession, Graham’svalue-oriented investing methodolo-gies have been the topic o countlessarticles and academic studies. In act,AAII tracks three dierent Grahammethodologies at the Stock Screensarea o AAII.com. However, his origi-nal stock selection approach has notgarnered the same attention as hislater concepts.Graham developed andtested the net current assetvalue (NCAV) approachbetween 1930 and 1932. Ac-cording to private investingrm Tweedy, Browne Com-pany: “The net current assetvalue approach is the oldestapproach to investment ingroups o securities withcommon selection character-istics o which we are aware.”Graham reported that theaverage return, over a 30-yearperiod, on diversied porto-lios o net current asset stockswas about 20%. An outsidestudy showed that rom 1970to 1983, an investor couldhave earned an average return o 29.4% by purchasing stocks thatullled Graham’s requirement andholding them or one year. The topic o two “First Cut” col-umns by John Bajkowski in the AAIIJournal (September 2007 and April2009), the NCAV approach is moreully explained in this CI Online Ex-clusive, highlighting how you can usecomputerized stock screening toolsto identiy stocks meeting Graham’scriteria.
Graham rst discussed net cur-rent asset value (NCAV) in the 1934