How to Find Bargain Stocks

How to Find Bargain Stocks

Net Current Asset Value and its Amazing Performance Record

12 Stocks Selling Below NCAV Right Now

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How to Find Stocks Trading Below Liquidation Value

An infinite number of methods are available for you to evaluate stocks with the same intended goal: To find stocks that will soar over the next many months or years.

Benjamin Graham, in his book The Intelligent Investor, introduced a simple formula to identify stocks that he referred to as "bargain issues." The formula, created 80 years ago, is known as the NCAV equation, which is short for Net Current Asset Value. Astonishingly, Ben Graham's simple equation has very likely produced the best performance results of any method during the past several decades.

To calculate NCAV, also referred to as Net-Net, follow these three steps:

1.) Subtract the total liabilities of a company from the company's current assets,
2.) Divide the result by the company's outstanding shares. This is NCAV.
3.) Divide the current price per share by the NCAV. This step computes the Price to NCAV ratio, which is the measure used to find "bargain issues."

Low price to NCAV ratios can lead to amazing results, as demonstrated in the chart below. The chart shows the average performance of stocks trading below 75% of net current asset value from 1956 to 2010. No more than 10% was invested in any one stock. If only a few stocks were available selling at less than 75% of NCAV, the balance of the portfolio was invested in Treasury Bills. Despite investing a portion of the portfolio in Treasury Bills, the long-term performance is excellent relative to the Standard & Poor's 500 Index.

What are the Advantages of Using the NCAV Equation?

One of the features I like about the NCAV equation is that it doesn't involve any future projections or estimates. The ingredients of the equation include the latest reported current assets, total liabilities, common shares outstanding and current share price. That's it!

Stocks trading at less than net current asset value inherently provide a large margin of safety. No value was ascribed to any fixed assets, because we are paying for current assets without including any long-term or fixed assets. The fixed assets are free! The company could be bought and put into liquidation and we should expect to get back more than the price paid. Buying at such a low value maximizes the upside and minimizes the downside.

There are many reasons stocks might sell at truly bargain prices. Sometimes a stock has been underperforming the stock market for quite a long time, causing investors to give up on it. Stocks can also come with a certain amount of "baggage" caused by past problems of all sorts, making their outlook doubtful.

Other reasons stocks will trade at these extremely low valuations include changes in technology, legal issues, mismanagement and new competition. Whatever the reason, stocks with low price to NCAV ratios have been driven down to extremely low prices and are destined to recover.

Stocks selling at only 75% of NCAV are sometimes hard to find, especially after a long run-up in the stock market, like the one we have enjoyed during the past five years. However, if you dig deep, you can find them.

If the results are so clearly in the favor of NCAV stocks, why isn't every equity investor following this approach? One reason is that the stocks are typically small cap stocks, which are unattractive for large portfolio managers and unprofitable for brokerage firms to research.

My Findings

I use AAII's (American Association of Individual Investors) database of 7,000 companies. A recent quick study of the database produced a total of 92 stocks selling at less than 75% of NCAVs. Of these, 49 stocks are selling at prices exceeding \$0.75, which is usually my minimum for possible investment.

According to studies, foreign companies with low current price to NCAV ratios perform just as well as U.S. companies. However, I feel more comfortable excluding Chinese companies from consideration, because of China's dubious oversight of small companies. I'll leave it up to my colleague, Paul Goodwin, to find Chinese companies with trustworthy financial statements for his Cabot China & Emerging Markets Report.

I also eliminated stocks that trade in the Over the Counter Market. These companies might be worthwhile investments, but I eliminate them because of their possible lack of liquidity.

Excluding Chinese companies and companies trading Over the Counter left me with 12 companies with current price to NCAV ratios less than 0.75 and current prices above \$0.75. The 12 companies listed below might possibly perform well during the next 12 months, but I have not yet evaluated important company attributes such as sales, cash flow, earnings, dividends or book value.

I will research the 12 stocks listed below during the next few days and choose the best buy candidates and include them in my Cabot Benjamin Graham Value Investor Special Features Model published on July 10.

Simply click here to subscribe  to the Value Investor to receive continuing coverage of NCAV stocks with exceptional appreciation potential.

Aviat Networks ( AVNW )
CHS, Inc. ( CHSCP )
Coast Distribution System (CRV)
Gravity Co. (ADR) ( GRVY )
Paulson Capital (PLCC)
STR Holdings ( STRI )
Taitron Components (TAIT)
Trans World Entertainment (TWMC)
Transcept Pharmaceuticals (TSPT)
TSR, Inc. (TSRI)
Vicon Industries (VII)

Current prices of these stocks (as of the June 27 market close) range from \$0.83 to \$31.77. Current price to NCAV ratios range from 0.49 to 0.75. These stocks are considerably more risky than my usual stock choices, but past performance results indicate that the risk is quite worthwhile.

Lastly, I invite you to follow me on Twitter at " @J_Royden_Ward. " I send out at least one interesting tweet every day.

Until next time, be kind and friendly to everyone you meet.

Sincerely,

J. Royden Ward
Chief Analyst, Cabot Benjamin Graham Value Investor

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ, Inc.

Referenced Stocks: AVNW , MSN , GRVY ,

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