According to Benjamin Graham, a very famous American economist, investor, professor and the author of the best-selling book ‘The intelligent Investor’ (which changed lives of many including Warren Buffett), majority of people overlook the asset value of share and obsess over a company’s earnings.
Net Current Asset Value Per Share or NCAVPS was initially introduced by Graham (also known as the ‘father of value investing’). It is a fundamental value for investors to compare companies. It is nothing but the value of current assets subtracted by total liabilities including preferred stock divided by the total number of outstanding shares.
Therefore, NCAVPS = (Current assets – total liabilities)/Total number of outstanding shares
But why only current assets? NCAVPS method is a very strict method of valuation considering only current assets. It does not consider fixed assets.
The key point for investors to remember is that they should only invest in a company when its stock is trading below what the firm would sell for in the open market.
Let’s take one example,
Long term investments
Long term debt
Therefore, NCAVPS =(Current assets – total liabilities)/Total number of outstanding shares
Assume, current market price is Rs. 15
Since 50% < 66%, the stock is undervalued
Let us take another example,
Now let us say that the company ABC’s share value is trading at $10 and estimated NCAVPS value is $20. But there are three scenarios to this,
- The management is well focused and work towards the growth of the company. In this case, we should go for this opportunity.
- However, what if it is just the opposite of the first scenario, it will only lower the share price further, even below the NCAVPS value. So never opt for it.
- Finally, the last thing that could happen is that the company has been reporting losses since last 5 years and is trading below the NCAVPS value, in this case we should not be opting for loss making stocks.
First thing to look out for is that the price should be lower than the NCAVPS value. Also, there must be a low debt-to-equity ratio. A low debt-to-equity ratio means having a large margin of safety. I won’t invest in a company that has a debt-to-equity ratio of over 25%.
You would want the company to have recorded adequate past earnings over the last few years.
One should also look out that whether in the past the price has gone above NCAVPS value because to me, when a company’s stock has traded below NCAVPS for years then it’s a red flag.
Now, let’s discuss who should not go for NCAVPS: –
Less risk:The investors who wants to go for a less risky method should not go for this method because with volatility comes the risk of losing money.
Long term: The investors aiming for a long-term view should not go for this method and the reason behind this is, liquidation amount of a company can be much different. Most of the assets may be sold below market price and potentially less book value. If the assets are sold for less than their book value, the NCAVPS formula will overestimate the liquidation value of the company.
Don’t like buying small caps: This method is for people who like to invest in small cap companies.
OTC stocks: People who don’t like over the counter stocks should not go for NCAVPS.
Innovation: Such stocks are for people who like try innovating and try new things in the market.
So now what exactly are the limitations to this method:
First of all we need to know that one has to take a look at earnings of a company because if a company has been suffering losses from the past 5 years may trade at NCAVPS level, so should one buy the stock? Not at all.
Also, it takes a lot of time for investors to know what shares are trading at NCAVPS levels.
Another thing as discussed above is that estimating a liquidation value of the company is difficult since during liquidation many assets may not sell immediately and may sell less than the market price and potentially less than the book value also known as distressed price.
Having NCAVPS method why follow other criteria as well? Because Benjamin Graham once said, before you invest, you must ensure that you have realistically assessed your probability of being right and how you will react to the consequences of being wrong.
There are usually 19 criteria to look out for:
Book value: According to our famous google search, book value is the value of a security or asset as entered in a firm’s books. Often contrasted with market value.
Tangible value: Tangible value is the potential value that investors can calculate.
Tangible book value: It is nothing, but the value of all assets subtracted by the intangible assets.
Intangible value: Intangible value is of things such as copyrights, patents, etc. These assets intangible (cannot be touched or seen)
Enterprise value: Enterprise is the market cap value of the company. It is what another company would pay for buying it out.
Franchise value:It is the value for the reputation or name of the company.
Dividend value: It is basically the value of returns investors make. It is usually calculated by subtracting annual pay off from the share price.
Negative Enterprise value: It is when the cash exceeds the debts and market cap.
NCAVPS: As discussed it is a popular method by Benjamin Graham.
PE Ratio: P/E Ratio or Price to Earnings Ratio is the ratio of the current price of a company’s share in relation to its earnings per share (EPS).
Low institutional ownership: These are basically companies that are yet to be discovered.
Higher insider ownership: It is when the management’s main interest is the success of the company.
Revenue: Look at the revenues the company is earning
Cost of revenue: It is lower cost for revenues earned.
Operating income/loss: It is the amount the company earns from its daily operations.
Net income/loss: It is the net profit and loss earned throughout the year.
Free cash flow: It is the amount left after the company’s operations.
Financial cash flow: It is the amount invested by the company, the higher the better.
Cash and cash equivalents: It is a method to look at the cash flow of a company to see how the company is doing.
NCAVPS method is one way of valuing stocks, it is a very strict method of valuation which considers only current asset so yes, I believe that there is no perfect way of valuing stock, but one can just go with the one they are comfortable at.
Thanks for reading and all the best for future returns