From Tweedy -Browne..
ASSETS BOUGHT CHEAP
BENJAMIN GRAHAM’S NET CURRENT ASSET VALUE STOCK SELECTION CRITERION
The net current asset value approach is the oldest approach to investment in groups of securities with common selection characteristics of which we are aware. Benjamin Graham developed and tested this criterion between 1930 and 1932.
The net current assets investment selection criterion calls for thepurchase of stocks which are priced at 66% or less of a company’s underlying current assets (cash,receivables and inventory) net of all liabilities and claims senior to a company’s common stock (currentliabilities, long-term debt, preferred stock, unfunded pension liabilities).
For example, if a company’scurrent assets are $100 per share and the sum of current liabilities, long-term debt, preferred stock, and unfunded pension liabilities is $40 per share, then net current assets would be $60 per share, and Grahamwould pay no more than 66% of $60, or $40, for this stock. Graham used the net current asset investmentselection technique extensively in the operations of his investment management business, Graham-Newman Corporation, through 1956.
Graham reported that the average return, over a 30-year period, ondiversified portfolios of net current asset stocks was about 20% per year.In the 1973 edition of The Intelligent Investor, Benjamin Graham commented on the technique:”It always seemed, and still seems, ridiculously simple to say that if one can acquire adiversified group of common stocks at a price less than the applicable net current assetsalone — after deducting all prior claims, and counting as zero the fixed and other assets –the results should be quite satisfactory.”
In an article in the November-December 1986 issue of Financial Analysts Journal, “Ben Graham’s Net Current Asset Values: A Performance Update,” Henry Oppenheimer, an Associate Professor of Finance atthe State University of New York at Binghamton, examined the investment results of stocks selling at orbelow 66% of net current asset value during the 13-year period from December 31, 1970 throughDecember 31, 1983.The study assumed that all stocks meeting the investment criterion were purchased on December 31 ofeach year, held for one year, and replaced on December 31 of the subsequent year by stocks meeting the same criterion on that date.
To create the annual net current asset portfolios, Oppenheimer screened theentire Standard & Poor’s Security Owners Guide. The entire 13-year study sample size was 645 netcurrent asset selections from the New York Stock Exchange, the American Stock Exchange and the over-the-counter securities market. The minimum December 31 sample was 18 companies and the maximum December 31 sample was 89 companies.
The mean return from net current asset stocks for the 13-year period was 29.4% per year versus 11.5%per year for the NYSE-AMEX Index. One million dollars invested in the net current asset portfolio onDecember 31, 1970 would have increased to $25,497,300 by December 31, 1983. By comparison,$1,000,000 invested in the NYSE-AMEX Index would have increased to $3,729,600 on December 31,1983.
The net current asset portfolio’s exceptional performance over the entire 13 years was notconsistent over smaller subsets of time within the 13-year period. For the three-year period, December31, 1970 through December 31, 1973, which represents 23% of the 13-year study period, the mean annualreturn from the net current asset portfolio was .6% per year as compared to 4.6% per year for the NYSE-AMEX Index.The study also examined the investment results from the net current asset companies which operated at aloss (about one-third of the entire sample of firms) as compared to the investment results of the netcurrent asset companies which operated profitably.
The firms operating at a loss had slightly higherinvestment returns than the firms with positive earnings: 31.3% per year for the unprofitable companiesversus 28.9% per year for the profitable companies.Further research by Tweedy, Browne has indicated that companies satisfying the net current assetcriterion have not only enjoyed superior common stock performance over time but also often have beenpriced at significant discounts to “real world” estimates of the specific value that stockholders wouldprobably receive in an actual sale or liquidation of the entire corporation.
Net current asset value ascribes no value to a company’s real estate and equipment, nor is any going concern value ascribed to prospectiveearning power from a company’s sales base. When liquidation value appraisals are made, the estimated”haircut” on accounts receivable and inventory is often recouped or exceeded by the estimated value of acompany’s real estate and equipment. It is not uncommon to see informed investors, such as a company’sown officers and directors or other corporations, accumulate the shares of a company priced in the stockmarket at less than 66% of net current asset value. The company itself is frequently a buyer of its own shares.
Common characteristics associated with stocks selling at less than 66% of net current asset value are lowprice/earnings ratios, low price/sales ratios and low prices in relation to “normal” earnings; i.e., what thecompany would earn if it earned the average return on equity for a given industry or the average netincome margin on sales for such industry. Current earnings are often depressed in relation to priorearnings.
The stock price has often declined significantly from prior price levels, causing a shrinkage in acompany’s market capitalization.
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Disclosure (“none” means no position):
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