What is Benjamin Graham’s Model of Asset Valuation?

14 Sep 2019 Read 398 Views

Outside of Warren Buffet, no other investor is as well-known as his mentor Benjamin Graham.

The objective of Graham’s strategy is to identify unappreciated stocks and show you how to find undervalued stocks that meet certain criteria for quality and quantity … stocks that are poised for stellar price appreciation.

One of the models of asset valuation developed by Benjamin Graham is the "net current asset value per share."

Continue reading to know how his model will help you in investing better.

Net current asset value per share model is a method by which we can measure or estimate the attractiveness of the stocks in relation to the net current assets. It is a very conservative approach and calculates the intrinsic values of shares.

Why was this model developed?

By observing the industrial patterns, Graham noted that the investors considered the value of earnings rather than the value of assets of the company.

Since net current assets of the company represent the liquidity position, Benjamin was adamant that it was essential to take into consideration the net current asset before investing.

Performance of stocks evaluated under this approach

It is noted that stocks meeting Graham's approach performed much better as compared to the broad market average. With an average return of 35.3% every year for 25 years and outperforming the market by an average of 22.4% per year.

How is the net current asset value per share calculated?

NCAVPS is calculated by subtracting the total liabilities from the current assets of the firm and then diving the resultant by the number of shares outstanding.

Note: Since Benjamin took preferred stock as a liability, its value is also deducted from the current assets.

Formula: NCAVPS= current assets- (total liabilities+ preferred stock)/ outstanding shares

Example:

A Company MNS has Rs7million in current assets, Rs3 million in current liabilities, and Rs1 million outstanding shares.

Then, the NCAVPS would be:
NCAVPS= current assets- (total liabilities+ preferred stock)/ outstanding shares
NCAVPS= 7000000-3000000/1000000
NCAVPS= Rs4 per share

What is a good NCAVPS?

Graham also advocated for purchasing stocks that were trading below 67% of their NCAV to allow the investor an adequate margin of safety.
Since in the example mentioned above the NCSVPS is calculated as Rs4, to find out whether the stocks of the company are safe to invest or not, we will multiply it by 67% and compare it with the price at which they are currently trading.

Therefore. 4*0.67 gives us Rs2.68; whereas, the current trading stock price of MNS is Rs2.50.
This implies that the current price of the stocks is below the liquidation value and margin of safety.

What are net-nets?

Net-nets is also known as net-net working capital (NNWC) attempts "revaluing" NCAV with the following adjustments:

  • +100% of cash and short-term investments
  • +75% of accounts receivables
  • +50% of inventories
  • -100% of all liabilities

The key difference between NCAV and NNWC is that NNWC looks purely at liquid and tangible asset value. It doesn’t include any prepaid expenses or even deferred taxes that NCAV includes.

Investors who have the following traits should not prefer NCAVs:

  1. Volatility averse: the investors who are risk-averse should stay away from these NCAVs. With volatility comes the risk of losing money.
     
  2. Long term investors: These stocks are not suitable for investors who wish to remain invested for the long term.
     
  3. Don’t like buying small caps: People who prefer to invest in small-cap companies are most likely to invest in such stocks in the market. These are the people who want to hold a more significant part of the ownership in these small-cap companies and have more rights in decision making.
     
  4. Don’t like analyzing OTC stocks: over the counter stocks are very common these days and requires negotiation and agreement between the two parties to sell shares at a specific rate. People who do not want to trade in OTC stocks and get involved in such negotiations and agreements should trade in stock other than NCAV.
     
  5. Want to stick to mainstream ideas: Such stocks are advantageous for investors who like to innovate and try out new options. However, the ones who are very traditional in their approach towards trading in stocks should not deal in NCAV.

Conclusion

Model of valuation of shares in respect to the net current assets of company by Benjamin Graham is a model which has given goods returns to the investors in the past and holds a possibility of giving the same kind of returns in today’s time as well.
This model will help you find out the liquidity position of the company.
Hence, once proper analysis of the company has been done by the investors in terms of NCAVPS model and other techniques, the investor should feel confident about its decisions.
To know more about assessing a company, Click Here.

About the Author: Sarah Singh Solanki | 11 Posts

Sarah is hardworking and has a  good sense of responsibility and job ethics. Efficient, effective and dedicated in any particular role. Highly determined towards securing an outstanding image among peers.

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