How To Pick Undervalued Stocks Using NCAVPS
NCAVPS is an immensely beneficial metric when it comes to value investing strategies
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Have you heard of Benjamin Graham? The British-born American was an iconic investor, economist and professor. But before becoming famous, he chose a career at Newburger, Henderson & Loeb as a 20-something graduate fresh out of Columbia University.
Graham swiftly climbed the ladder at his Wall Street firm and began teaching finance and writing. His first published work, ‘Security Analysis,’ was released in 1934 and went on to gain cult status. His 1949 work, ‘The Intelligent Investor,’ was hailed as “the best book about investing ever written” by none other than legendary investor Warren Buffet.
Why are you reading about Graham? Because besides being an investing legend, he’s been dubbed the ‘Father of Value Investing’ and ‘The Einstein of Money.’ Graham’s work on Net Current Asset Value Per Share (NCAVPS) is the foundational strategy for value investing.
So, if there’s one piece of investment lesson we can learn from Graham, it’s of valuing your stocks with the NCAVPS method. Investment platform Groww helps you learn how.
What is NCAVPS?
A key financial metric for value investors, NCAVPS measures how attractive a stock is as a prospective investment by deriving its intrinsic value. NCAVPS is calculated by subtracting the total liabilities of a company (including its preferred stock, which Graham considered a liability) from its current assets. The resulting figure is divided by the number of shares outstanding to get the per share value of current assets.
NCAVPS = Current assets – (total liabilities + preferred stock) / shares outstanding
To put it simply, the net current asset value is the value of a company’s assets if it were to be liquidated; the liquidation value if the assets were to be sold. The liquidation value includes tangible assets such as real estate, equipment and machinery, inventory and fixtures, and excludes intangibles like brand equity, intellectual property and goodwill.
Graham was of the opinion that instead of focusing on a company’s earnings to gauge the potential of its stock, investors should also consider asset values. He proposed that by comparing a stock’s NCAVPS with its price, investors can derive the intrinsic value and identify undervalued stocks.
Why should you value your stocks through NCAVPS?
NCAVPS is widely considered one of the most effective methods of stock valuation and is immensely helpful when investing in undervalued stocks. Not only is it extremely simple to calculate, but it is also highly reliable.
Let’s assume that the NCAVPS is higher than the trade price of a stock and the company’s outlook is reasonably promising. This is an indication that the stock is undervalued, and investors are getting a buying opportunity at a price lower than its minimum value (remember, we’ve taken the liquidation value of assets). Stocks trading at NCAVPS values are certain to see appreciation and give a high return on investment.
As to how much lower than the NCAVPS should the stock price be to give investors a good yield on investment, Graham proposed a measure of around 67 percent. Investors should ideally put their money on a stock trading at a price no higher than 67 percent or two-third of its NCAVPS, which includes a safety margin after accounting for assets that aren’t easily liquidated, e.g., inventory.
For example, assume a company has 100 crore in assets, 10 crore in liabilities and 1 crore shares outstanding. In this case:
NCAVPS = Rs 100 crore – Rs 10 crore / 1 crore
This gives an NCAVPS of 90. If the trade price is Rs 60 or less, the fundamentally strong stock is undervalued and is sure to appreciate in the future.
Value investing with NCAVPS
Wise is an investor, however, who looks at NCAVPS and earnings in tandem. Why? Because a company incurring losses for the past many years may also be trading at a price considerably lower than its NCAVPS and should be avoided for its bleak outlook.
Regardless, NCAVPS is a beneficial metric for value investors, and once you get a hold of the value investing strategy using NCAVPS, it’s easy to see why Graham is still a legend in global financial markets.