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Testing Graham’s Net Current Asset Value

Strategy, Part 1
March 02, 2017, 12:50:56 PM EDT By Tuomo Saarnio, GuruFocus

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There have been various studies analyzing the performance of Benjamin Graham's strategy of
purchasing stocks trading below net current asset value (NCAV). These stocks are also called
net-nets. Graham developed and tested this criterion in the early 1930s and first described his
net current asset value rule for stock selection in the 1934 edition of "Security Analysis."

The common definition of net current asset value is:

NCAV = current assets - (total liabilities + preferred stock)

The first studies and the majority of examinations were done in the U.S. Later, other studies
were conducted in major international markets. Although there were many differences across
each study, a general conclusion was that stocks meeting Graham's net current asset value
criterion outperform a broad market average. In addition, the outperformance has been superior
most of the time.

Various studies conducted over the years

In the "Intelligent Investor," Graham provides evidence to illustrate the power of his net-net
approach. Graham tested his strategy by buying one share of each of the 85 companies that
met his net-net criteria on Dec. 31, 1957, holding them for two years.

Graham was not content with just buying companies trading at prices less than their net current
asset value. He required a greater margin of safety, buying only stocks trading at prices less
than two-thirds of their net current asset value. The gain for the entire portfolio in that period
was 75%, against 50% for the S&P 500's 425 industrials. What was more remarkable was that
none of the stocks showed significant losses, seven held about even and 78 showed
appreciable gains.

Henry Oppenheimer, professor of finance at State University of New York at Binghampton,

examined the returns to Graham's net current asset value strategy over a 13-year period from
Dec. 31, 1970 to Dec. 31, 1983. Oppenheimer's study assumed that all stocks meeting the
investment criterion were purchased on Dec. 31 of each year, held for one year and replaced
on Dec. 31 the following year by stocks meeting the same criterion on that date.

Oppenheimer used the same two-thirds margin of safety of net current asset value as Graham.
The total number of researched net-net stocks was 645. The smallest annual sample was 18
stocks and the largest was 89. Oppenheimer found the average return over the 13-year period
he examined was 29.4% per year compared to 11.5% for the NYSE Amex index. A $10,000
investment in the net current asset value portfolio would have increased to $285,197. In
comparison, a $10,000 investment in the market would have increased to just $41,169.

Carbon Beach Asset Management founder Tobias E. Carlisle, who is known for his books
"Deep Value", "Quantitative Value"(co-authored with Wesley Gray) and "Concentrated
Investing" (co-authored with Allen C. Benello and Michael van Biema), tested the performance
of Graham's net current asset value strategy with Jeffrey Oxmanin and Sunil Mohantyn of St.
Thomas University. They continued the examination from the end of Oppenheimer's data in
December 1983 to Dec. 1, 2008.

The net current asset value strategy returned, on average, 35.3% every year for 25 years. It
outperformed the market by an average of 22.4% per year and a comparable Small Firm Index
portfolio by an average of 16.9% per year. The lowest net-net selection was only 13 stocks in
1984 and the highest number of net-nets, 152 stocks, were found in 2002.
Joseph D. Vu published his examination of the performance of Graham's net current asset
value strategy in the Financial Review in 1988. His study, "An Empirical Analysis of Benjamin
Graham's Net Current Asset Value Rules," was conducted to provide evidence that the net
current asset value rule established by Ben Graham in 1930 was still profitable in the 1970s
and 1980s. Vu researched return of net-net stocks in U.S. markets from April 1977 to
December 1984. Stocks meeting Graham's criterion returned, on average, 38.5% every year,
compared to 32.1% for the market index.

Famous value investors Joel Greenblatt ( Trades , Portfolio ) and Richard Pzena (Trades,
Portfolio), together with money manager Bruce L. Newberg, published their findings in the The
Journal of Portfolio Management in 1981. Greenblatt and his co-authors argued that the only
way the small investor can beat the market is by looking for undervalued stocks.

To start, they used Graham's traditional net-nets formula to screen for bargains. After using
this, Greenblatt went further in an attempt to remove bad stocks from the list. To accomplish
this goal, the authors added the price-earnings ratio to their NCAV screening criteria. Using
both Graham's net current asset value and the P/E ratio, Greenblatt tested four different
portfolios and compared them to the OTC and Value Line's own value index from April 1972 to
April 1978. This period was characterized by an extreme amount of volatility.

Stocks with a market cap of less than $3 million were discarded from the study. Stocks were
sold after a 100% gain or two years had passed, whichever occurred first.

The returns of the four portfolios were following:

 Portfolio 1 returned 20.0% per year.

 Portfolio 2 returned 27.1% per year.
 Portfolio 3 returned 32.2% per year.
 Portfolio 4 returned 42.2% per year.

Inspired by the study, Greenblatt founded hedge fund Gotham Capital, which returned an
average 40% per year from 1985 to 2006. Gotham's stellar performance came from deep-value
and special situations investing and the maintenance of an extremely concentrated portfolio.

Victor J. Wendl, president ofWendl Financial, published a book, "The Net Current Asset Value
Approach To Stock Investing," where he analyzed how the net current asset value method
performed over the 60 years from 1951 to 2009. Stocks were included in the portfolio if the
current trading price was below 75% of the net current asset value calculation. Stocks were
held between one and five years. In summary, longer holding periods gave weaker results.

The study also showed that, in general, the more undervalued a stock is relative to its net
current asset value, the higher the future return. Additional criteria, like low P/E ratios and
dividend yields were also studied. The net current asset value portfolio (return 19.89%) beat
both the S&P 500 index (return 10.67%) and Wilshire Small-Cap index (return 11.20%) by a
wide margin.

Chongsoo An, John J. Cheh and Il-woon Kim published their own study in Journal of Economic
& Financial Studies in February 2015. The study period was from Jan. 2, 1999 to Aug. 31,
2012. The results were compared to the performance of the S&P 500.

In their study, stocks were divided in three different portfolios:

 Portfolio 1: Net Current Asset Value/Market Value > market pricex1

 Portfolio 2: Net Current Asset Value/Market Value > market pricex2
 Portfolio 3: Net Current Asset Value/Market Value > market pricex5

The final sample size for each portfolio, respectively, was 84 companies, 32 companies and 10
companies. The portfolios were rebalanced yearly.

The annualized returns of the three portfolios are:

 Portfolio 1: 17.17%
 Portfolio 2: 17.78%
 Portfolio 3: 18.34%

The performance of S&P 500 during the same period was 2.91%. As the stock holding period
decreased from one year to six months, and finally to four weeks, returns generally decreased
and could not beat the market anymore.

These results are not just limited to the United States.

Famous value investor and behavioral finance expert James Montier examined the
performance of net-net stocks on a global basis. He purchased a portfolio of net-net stocks in
all developed markets globally over the period of 1985 to 2007. The returns of this investing
strategy were impressive. An equally-weighted basket of net-nets generated outstanding
average returns of 35% per year versus market returns of 17% per year. The net current asset
value strategy worked well at the global level. Within regions, these stocks outperformed the
market by 18% in the U.S., 15% in Japan and 6% in Europe.

In the first study outside of the U.S., J.S. Bildersee, J.J. Cheh and A. Zutshi tested the strategy
in the Japanese market from April 1975 to March 1988. The study was published in Japan and
the World Economy in 1993, entitled "The Performance of Japanese Stocks in Relation Their
Net Current Asset Values."
In order to maintain a sample large enough for cross-sectional analysis, Graham's criterion was
relaxed so that companies are required to merely have a net current asset value-market value
ratio greater than zero. The study's net current asset value portfolio returned 20.55% and the
market index returned 16.63% annually over the same period. Not a big difference, but it was
obviously a difficult period in Japan. The Nikkei index peaked at the end of 1989 and never

Ying Xiao and Glen C. Arnold from Salford Business School examined the net current asset
value-market value strategy in London. The research period was from January 1980 to
December 2005. Portfolios were formed annually in July. To be included in the sample for the
year, companies had to have data for NCAV in December of t-1 and at least one return
observation in the post-formation period. The six-month lag between the measurement of
NCAV and return data allowed for a delay in the publication of individual companies' accounts,
thus ensuring the financial statements are public information before the returns are recorded.
Only those stocks with two-thirds of net current asset value are included in the portfolios. The
holding periods for the portfolios ranged from one year to five years. A one-year holding period
returned 31.19% against the market's 20.51%. Two years returned 75.11%, three years
126.27%, four years 191.62% and five years 254.02%. One million pounds ($1.2 million)
invested in equally weighted net current asset value portfolios starting on July 1, 1981 would
have increased to 432 million pounds by June 2005. By comparison, one million pounds
invested in the entire U.K. market would have increased to 34 million pounds by end of June
2005. A huge difference in the long term.


A review of the studies clearly show that regardless of the differences in methodology and the
markets where these studies were conducted, stocks meeting Graham's net current asset value
criterion outperformed a broad market average - and notably. Not only did the strategy return
continued superior performance, it also had fewer losing years.

In the next part of this series, we will look at different value investors in their practical work
using Graham's method.

More information:

 James Montier: "Value Investing; Tools and Techniques for Intelligent Investment"
 Tobias E. Carlisle: "Deep Value"
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3. A DIY Guide on How to Invest Using Guru Strategies

Tuomo Saarnio
Articles (20) | Author's Website |



Testing Graham’s Net Current Asset

Value Strategy, Part 2
The strategy in practice
March 08, 2017 | About: SSI +0%

In the first part of this series testing Benjamin Graham’s net current asset value (NCAV) strategy,
we reviewed different studies that confirmed the effectiveness of this strategy in regard to

But what about reality? No one can purchase every single net-net stock. You have to make
choices, commissions must be paid. The spread between bid and ask prices can make it difficult
or expensive to purchase these stocks.

Graham’s strategy in practice

Studies differ from reality, and only the execution of the strategy will prove its effectiveness. The
best proof for the success of Graham’s method lies with those investors who have used it. Their
success in real markets will be the best evidence for us.
Benjamin Graham

As the developer of the strategy, Graham is the first and best evidence of the success of his
method. According to Graham-Newman's letters to partners, the returns between 1926 and 1956
were about 20% annually. Of course, they used other strategies like special situations, but net-
nets were a very important part of this portfolio.

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Walter Schloss

One of the most successful deep-value investors was Walter Schloss. His exceptionally long
career and great track record is still unbeaten. He worked for Graham at Graham-Newman
before starting his own partnership in 1955. From 1955 through 2002, Schloss managed the
company. His son, Edwin, joined the partnership in 1973 and it became Walter & Edwin Schloss
Associates. The compound annual rate of return for his firm was about 21% per year, compared
to the S&P Industrial Average's gain of 11% per year.

Irving Kahn

Another alumnus of Graham, who was also his teaching assistant at Columbia Business School,
was Irving Kahn. Kahn was a chartered financial analyst and founded Kahn
Brothers (Trades, Portfolio) Group with his sons, Thomas and Alan, in 1978. Kahn began his
career in 1928 and continued to work until his death (aged 109) in 2015. Kahn Brothers
continues its successful investment operations, led by Thomas Kahn. As the fund got bigger, the
firm's investment philosophy evolved from Graham's original "discount to net asset purchase"
model into a contrarian value strategy focusing on margin of safety and capital appreciation over
long periods of time.

Warren Buffett

You cannot talk about Graham’s disciples without mentioning the most famous one, Warren
Buffett(Trades, Portfolio). When Buffett began his career, Graham’s net current asset value
strategy was one of his most important methods. Buffett called it cigar-butt investing. According
to his letters to shareholders, from 1957 until end of 1968, Buffett achieved an average return of
31.6%, compared to the tiny 9.1% return of S&P 500 index.

Charles Brandes
California-based Charles Brandes (Trades, Portfolio) met Graham in the early 1970s while still
managing the front desk of a small brokerage firm in La Jolla, California. Inspired by Graham,
Brandes ventured out and started his own firm, Brandes Investment Partners, in 1974. By
applying the value-oriented investing principles of Graham and Dodd, Brandes seeks deeply
undervalued stocks. Brandes has also written several books, including ”Value Investing Today”
and ”Brandes on Value: The Independent Investor.”

Tweedy, Brown Co.

Another global value investing powerhouse is Tweedy, Brown (Trades, Portfolio). The firm was
established in the 1920s as a dealer in closely held and inactively traded securities. Graham-
Newman Corp. was one of the firm's primary brokerage clients in the 1930s, 40s and 50s. After
the retirement of founder Bill Tweedy, Tom Knapp joined the firm in 1957 from Graham-Newman
and led its conversion from broker to investor with Howard Brown and Joe Reilly. The firm's
investment approach derives from Graham's work. Even today, they have an eye for deep-value
investments involving some net-nets.

Peter Cundill

Deceased Canadian value investor Peter Cundill's love for travelling turned him into one of the
best global investors. After reading about Graham in George Goodman’s “Super Money,” Cundill
knew what he wanted to do for the rest of his life. Cundill started Peter Cundill & Associates Ltd.
in 1974. Throughout his career, he was a pure deep-value investor. He once said, “Ninety to 95%
of all my investing meets the Graham tests. The times I strayed from a rigorous application of this
philosophy, I got myself into trouble.”

From 1974 to 2006, Cundill earned his investors a 19% annual compound return. The firm's
assets under management surged from $10 million to nearly $20 billion.

Seth Klarman

Seth Klarman (Trades, Portfolio) might be the most prestigious of all modern value investors –
after Buffett. As a young student, Klarman worked for legendary value investors Max Heine
and Michael Price (Trades, Portfolio) of the Mutual Shares fund. It was excellent place to learn
about value investing. He founded his own hedge fund, The Baupost Group, in 1982. Klarman is
a traditional value investor looking for companies, bonds, credit instruments and real estate
opportunities trading below what he and his analysts believe are their intrinsic values. Klarman is
a very conservative investor and often holds a significant amount of cash. On average, Baupost
has returned nearly 20% annually, which is an amazing return considering the size of the fund.

Joel Greenblatt
Joel Greenblatt (Trades, Portfolio) is famous for his books ”You Can Be a Stock Market Genius,”
”The Little Book That Beats the Market,” ”The Little Book That Still Beats the Market” and ”The
Big Secret for the Small Investor,” which are all classics. In his first book, “You Can Be a Stock
Market Genius,” Greenblatt deals excellently with special situation investing. In 2009, Greenblatt
introduced Magic Formula Investing in his best-selling book, “The Little Book That Beats the
Market.” His Gotham Asset Management earned annual average returns of about 40% from
1985 to 2006. Greenblatt’s first few years of astonishing returns came mainly from special
situations and net-net investing.

Bruce Berkowitz

Bruce Berkowitz (Trades, Portfolio) started his investing career with Merrill Lynch. He then
worked as a senior portfolio manager at Lehman Brothers Holdings and as a managing director
at Smith Barney. Berkowitz read Berkshire Hathaway's (BRK.A)(BRK.B) annual reports, which
led him to the works of Graham. In 1997, Berkowitz started his own firm, Fairholme Capital
Management. Fairholme's strategies are rooted in Graham-Dodd methods. Berkowitz is looking
for deeply undervalued and distressed stocks. He is a focused investor who manages a
concentrated portfolio. His top ideas represent a major portion of the portfolio. Berkowitz was
named the 2009 Domestic-Stock Fund Manager of the Year and the 2010 Domestic-Stock Fund
Manager of the Decade by Morningstar.

David Einhorn

David Einhorn (Trades, Portfolio) is a modern comprehensive value investor whose toolbox
contains almost all instruments of value investing. Einhorn founded Greenlight Capital in 1996
with just $900,000 under management. In his book, Einhorn describes how he put 15% of his
fund into a small Graham net-net, C.R. Anthony. After that, he really found early success. Stage
Stores Inc.(NYSE:SSI) bought out C.R. Anthony shortly after Greenlight Capital established the
position. The company finally returned 500% and Greenlight returned 37% for the year - and the
rest is history. Recently, Einhorn has become known for short selling, special situation investing
and being an activist in many companies. He is an investor worth paying attention to for his
value-based fundamental approach, excellent research and long-term focus. Since its inception,
Greenlight has returned an average of 29% annually.


One might wonder why Graham’s strategy is not more popular among professional investors
since the evidence for strong outperformance is undeniable. One of the reasons is its lack of
scalability. Huge funds with billions of dollars under management cannot implement this
approach with such rigorous stock selection criterion. The amount of money needed under
management for the fund to be profitable and the extreme selectivity of the filtering criterion are
incompatible from a business model standpoint. Especially when the market is high, Graham’s
NCAV screen eliminates too many stocks. During those times, it may even be a problem for
smaller private investors. Of course, if your playground is global, you will have more stocks to
choose from. Roughly speaking, if you have less than $1 million under management, you can
use a solely NCAV strategy. If you have over $10 million, it can be only part of your overall
The Two Best Investment Strategies
to Use According to Benjamin
Investing advice given by Graham before his death
March 08, 2018

Shortly before he died, Benjamin Graham was interviewed by the "Financial Analyst Journal,"
where he spoke about his life and investing career. Published in 1976, the interview was called
"A Conversation with Benjamin Graham." Today, his advice is still highly relevant and

Below, I have provided some extracts from the interview. Specifically, these extracts focus on
Graham's advice for the average investor when creating a portfolio. Graham recommends two
approaches for the average investor, both of which revolve around the idea of buying
undervalued stocks and attractive prices.

Question: : "Can you indicate concretely how an individual investor should create and maintain
his common stock portfolio?"

Graham: "I can give two examples of my suggested approach to this problem. One appears
severely limited in its application, but we found it almost unfailingly dependable and satisfactory
in 30-odd years of managing moderate-sized investment funds. The second represents a great
deal of new thinking and research on our part in recent years. It is much wider in its application
than the first one, but it combines the three virtues of sound logic, simplicity of application, and
an extraordinarily good performance record, assuming--contrary to fact--that it had actually been
followed as now formulated over the past 50 years--from 1925 to 1975."

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The first technique is Graham's well-known net-nets strategy, buying equities that are currently
trading at a deep discount to the value of their working capital or net current asset value. Graham
used this approach for many years successfully while running the Graham Newman Corp., but its
effectiveness is limited in bull markets, which means you have to be extremely patient if you want
to adopt the strategy.

Question: "Some details, please, on your two recommended approaches."

Graham: "My first, more limited, technique confines itself to the purchase of common stocks at
less than their working-capital value, or net-current-asset value, giving no weight to the plant and
other fixed assets, and deducting all liabilities in full from the current assets. We used this
approach extensively in managing investment funds, and over a 30-odd year period we must
have earned an average of some 20 per cent per year from this source. For a while, however,
after the mid-1950's, this brand of buying opportunity became very scarce because of the
pervasive bull market. But it has returned in quantity since the 1973-74 decline. In January 1976
we counted over 300 such issues in the Standard & Poor's Stock Guide--about 10 per cent of the
total. I consider it a foolproof method of systematic investment--once again, not on the basis of
individual results but in terms of the expectable group outcome."

The other approach is a simple low valuation approach. Buying stocks trading at a historic price-
earnings ratio of less than seven. This requires much less effort than the first approach, but as
Graham notes, his studies indicate this strategy still yields impressive mid-teens returns over the
long term, which still seems a good trade-off considering the vast amount of extra effort required
in the first approach.

Question: "Finally, what is your other approach?"

Graham: "This is similar to the first in its underlying philosophy. It consists of buying groups of
stocks at less than their current or intrinsic value as indicated by one or more simple criteria. The
criterion I prefer is seven times the reported earnings for the past 12 months. You can use
others--such as a current dividend return above seven per cent or book value more than 120
percent of price, etc. We are just finishing a performance study of these approaches over the
past half-century--1925-1975. They consistently show results of 15 per cent or better per annum,
or twice the record of the DJIA for this long period. I have every confidence in the threefold merit
of this general method based on (a) sound logic, (b) simplicity of application, and (c) an excellent
supporting record. At bottom it is a technique by which true investors can exploit the recurrent
excessive optimism and excessive apprehension of the speculative public."