Problems can be opportunities.
But how do you distinguish an opportunity from a real problem? Among a group of troubled stocks, how does an investor know which one are worth investing in? For that, we look to the Father of Value Investing for an answer.
Benjamin Graham believes that a stock offers great margin of safety when it is trading below two-thirds of the difference between its Current Assets and Total Liabilities. He calls this Net Current Asset Value or NCAV in short. Please do not mistake NCAV with BigFatPurse’s Conservative Net Asset Value (CNAV). They are not the same! Depending on the types of assets the company has, NCAV can be more conservative than CNAV and vice versa.
For those who do not understand the terms, fret not. I will explain them. Current Assets are assets that can be liquidated within a year while Non-current Assets are expected to be held beyond one year. Total Liabilities are all debt and payment obligations, inclusive of both current and non-current Liabilities, that the company needs to fulfil. Just remember that Current Assets are very liquid like your cash savings in the bank. They can be easily attained when needed.
Uncle Ben explained that assuming a company is running into troubles, it is opportune to invest if the current assets which can be quickly converted to cash to cover the debt obligations in great excess. The business may turn around and the investor makes a profit easily due to the low investment cost. Even if it goes into liquidation eventually, it is likely the investor would get back the money that he had paid for the stocks.
Warren Buffett was picking these cigar butts when he started out investing. These stocks were called cigar butts because they are near the end of life. A smoker can pick it up and enjoy the last puff at almost no cost. Warren Buffett had good successes with this approach until Charlie Munger convinced him otherwise to put his intelligence and wisdom somewhere else.
There are views that Uncle Ben’s NCAV worked very well in the past because financial stock data is not readily available. The assumption is that NCAV stocks are no longer available because such information can be found on a computer in the comfort of your home.
This is a myth. Information flow is not uniform across the public listed stocks. Most investors are not diligent enough to look through the universe of stocks. They would mainly rely on media to bring them news about companies. These reports usually cover the prominent companies, leaving smaller stocks in the shadow. Such information inefficiency results in undervaluation and existence for NCAV stocks.
Secondly, these NCAV stocks may be in a bad shape and investors became overly pessimistic and priced them ridiculously low. Most investors are too afraid to invest in them. In short, NCAV stocks will always exist because of investors’ irrationality.
I ran a NCAV screen on SGX stocks and found 23 stocks (I excluded S-Chips) which passed the criteria. The results are published here to short cut your research if you are interested in NCAV stocks. I would expect the data to be useful for seasoned investors only. Some of these stocks can be opportunities if you care enough to study them deeper.
To further protect your downside, Uncle Ben suggested to hold a portfolio of diversified NCAV stocks. This is in case there could be some lemon NCAV stocks which you may be invested in and you want to minimise the loss when you are wrong. The risk per stock is reduced when you have more stocks in the portfolio. The majority of the NCAV stocks should do well and contribute to an overall positive portfolio return.
WARNING! : This is not a recommendation to buy or sell stocks. The risk is high as NCAV stocks may be problematic companies. You need to be conversant with fundamental analysis in order to evaluate the risk and reward of the individual stocks. This stock screen alone is not adequate for making any investment decision. You should stay away if you do not understand how NCAV works and if your risk appetite is low.
|Name||Symbol||2/3 NCAV||Stock Price||NCAV-Price Difference|
|Combine Will 100||N0Z||1.3308||0.5150||0.8158|
|Fung Choi Media||F11||0.1866||0.0720||0.1146|
|Next-Gen Satelite Comm||B07||0.0037||0.0030||0.0007|