I first learned the Ben Graham approach of net current asset value investing, or NCAV, back in the late 1980s, and I took to it like a fish to water. Buying companies below liquidation value just made a lot of sense to me. The downside was minimal most of the time, and the worst that could happen with most of these stocks is that they may bore you to tears for an extended period of time.
The approach is simple enough. We take all current assets and then subtract all liabilities and preferred stock, and the end result is the net current asset value. We want to purchase stocks that trade for less than that value by a significant margin.
I have practiced this method for years, and the vast majority of the stocks I have found using this method have worked out very well. Like buying healthy small banks at a discount to book value, it is one of those investing methods that are so profitable and so geared toward individuals rather than institutions that I have long struggled to understand why everyone doesn't do this with at least a portion of their funds.
Instead, very few of us use this approach. One fellow NCAV buyer is Victor Wendl, a financial adviser from St. Louis. He wrote a fantastic book last year called The Net Current Asset Value Approach to Stock Investing. He outlined the strategy and then looked at the historical results from several different aspects and found that NCAV investing exceeds market rates of return by a wide margin. If you haven't read it, you should, to become more familiar with exactly how this cigar-butt approach to investing can help you earn higher returns.
I caught up with Victor over the weekend, and we talked about the approach as well as his research and findings. He came to NCAV investing from a little different path than I did, as he saw it more as an odds-and-probability game than a simple cheapskate philosophy. He told me, "I always found it interesting to read about people who managed to beat the mathematical odds of a loser's game, such as card counters at a game of blackjack. The net-current-asset-value approach to stock investing is an example of a stock-selection approach that can beat the odds and outperform the S&P 500 over the long term. "
We also talked about the fact that in Graham's day, you could find a lot more of these super-cheap stocks than you can today, and only at bear market bottoms can you find a plethora of stocks trading below net current asset value. In Wendl's research, he looked at forming a portfolio of NCAV stocks, with no more than 10% in any stock at one time. The balance was held in Treasury bills. So if he could find only five stocks, he put 10% into each and held 50% cash. On the other hand, if he found 20 stocks trading at less than 75% of NCAV, he would put 5% into each. There were long periods of time when cash balance was quite high, and the approach still earned nearly double the stock market's long-term rate of return.
There is a little bit of a market-timing element to the NCAV approach, as there are fewer bargains at tops and many more at bottoms. Wendl pointed out that in his research, he found that "one of the worst-case annual returns of an index fund occurred in the year 2008. Investors lost approximately 37% over the calendar year, but our current-asset-value portfolio lost only about half that amount. The comparative better performance was the result of only a limited number of stocks that met our value selection criterion, resulting in a portion of funds sitting idle in Treasury bills."
As you might expect, there are not many NCAV bargains in today's extended market, and the majority of the opportunities that do exist are very small. Among slightly larger stocks, Trans World Entertainment (TWMC) trades for about 72% of NCAV, and Richardson Electronics (RELL) is currently trading at 86% of NCAV.
As with every long-term approach, the hard part is sticking to the method during those inevitable periods when it underperforms. Periods of relative underperformance can test investors' patience and discipline. Wendl told me, "If we do a snapshot comparison of rolling five-year periods, an index fund outperforms stocks purchased below current asset value around 30% of the time. While the index fund is out celebrating during these short bursts of euphoria, the value camp has to be disciplined and not abandon their investment philosophy by jumping back into stocks."
If you haven't read Wendl's book, you should, no matter what type of investor or trader you consider yourself. The evidence is compelling, and he puts the definitive numbers to what I have said for years. Buying super-cheap stocks and holding patiently delivers market-beating returns over time.