Net current asset value or NCAV gives us a way to find stocks that have significant margin of safety to its intrinsic value. Normally intrinsic value calculations are quite sensitive to assumptions made, and assumptions tend to vary a lot. NCAV is a much more conservative way of looking at the balance sheet. It removes the long term assets from the calculation of the book value.
Net Current Asset Value Formula
NCAV = Current Assets – Total Liabilities
The value of the current assets on the balance sheet tends to be very close to the market value of these assets. The total liability value is also very close to what the company actually owes to its creditors.
How do Value Investors Use NCAV?
Net Current Asset Value was Ben Graham‘s favorite metric to find investable value stocks. A P/NCAV screen gives us a more conservative balance sheet valuation metric compared to the standard Price/Book Value metric. Insisting on a P/NCAV < 1 will filter for stocks that have significant and liquid tangible assets on the books. When you consider what the calculation actually means, you will understand why.
When the net current asset value exceeds the market value of a company (P/NCAV < 1), it can be argued that an enterprising investor is able to purchase the entire company, convert all current assets to cash, and pay off all liabilities with the proceeds. The cash left over is enough to payback the investment amount. Our investor gets the long term assets for free and he is free to either liquidate these assets, or employ them in productive uses and enjoy the future returns.
The stocks that exhibit a NCAV greater than the market value of the stock are also called net-net stocks.
It is important to keep in mind that even as we consider only the current assets in the calculation, some of the current assets may not actually result in full recovery of its market value.
For example, inventory may be worth less than what is on the books. Some of the account receivable may be unrecoverable.
To hedge against these issues, many value investors will require a margin of safety to the NCAV. For example, it is not uncommon to see investors insisting on a margin of safety of 30% (P/NCAV < 0.7).
Alternatively, an investor may choose to discount the current assets that are likely to be unable to be 100% recoverable. Some investors may choose to discount the inventory by 25% and the AR by 50%. This makes the calculation very strict and complex, but it provides greater protection against risk of capital loss in the investment.
Historically Net-Net Stocks Do Better than the Market
One would imagine that deeper values with greater margin of safety should provide better returns long term. The historical experience bears this out in the US, Japanese and English stock markets
NCAV Screeners: How to Screen for Net Current Asset Value?
There are a few screeners on the internet that will help you find net-net stocks. I am generally not a big fan of these screeners, although they can certainly get you started. NCAV screeners tend to be premium products, and generally speaking the number of net-net stocks available in the market at any given time tend to be few.
I personally run a Price/Book Value screen and if there are net-net stocks, they will show up in this screen. Once you have the results, go through each stock by hand to figure out its NCAV and compare it to the market value. This method has the added advantage of providing you additional context that you will miss when you use a direct screener (for example, if there are many net-net stocks in a particular sector, you should consider the reasons why. Perhaps the entire sector is in decline and may never recover).
Also keep in mind that the net-net situation in any stock can disappear in two ways:
- The company market value recovers to exceed the NCAV. This will happen if the company goes on to create positive shareholder value. This is the best case as it will likely increase the stock price and show you the profits
- The company NCAV declines and falls under the market value. This will happen if the company is unprofitable and continues to destroy shareholder value. Buying a net-net stock in this case is no guarantee that you will have a profitable investment
You still need to do enough due diligence to assure yourself of the merits of the investment.