Jae Jun at Old School Value has a great post, NCAV NNWC Screen Strategy Backtest, comparing the performance of net current asset value stocks (NCAV) and “net net working capital” (NNWC) stocks over the last three years. To arrive at NNWC, Jae Jun discounts the current asset value of stocks in line with Graham’s liquidation value discounts, but excludes the “Fixed and miscellaneous assets” included by Graham. Here’s Jae Jun’s NNWC formula:
NNWC = Cash + (0.75 x Accounts receivables) + (0.5 x Inventory)
Here’s Graham’s suggested discounts (extracted from Chapter XLIII of Security Analysis: The Classic 1934 Edition “Significance of the Current Asset Value”):
Excluding the “Fixed and miscellaneous assets” from the NNWC calculation provides an austere valuation indeed (it makes Graham look like a pie-eyed optimist, which is saying something). The good news is that Jae Jun’s NNWC methodology seems to have performed exceptionally well over the period analyzed.
Jae Jun’s back-test methodology was to create two concentrated portfolios, one of 15 stocks and the other of 10 stocks. He rolled the positions on a four-weekly basis, which may be difficult to do in practice (as Aswath Damodaran pointed out yesterday, many a slip twixt cup and the lip renders a promising back-tested strategy useless in the real world). Here’s the performance of the 15 stock portfolio:
“NNWC Incr.” is “NNWC Increasing,” which Jae Jun describes as follows:
NNWC is positive and the latest NNWC has increased compared to the previous quarter. In this screen, NNWC doesn’t have to be less than current market price. Since the requirement is that NNWC is greater than 0, most large caps automatically fail to make the cut due to the large quantity of intangibles, goodwill and total debt.
Both the NNWC and NNWC Increasing portfolios delivered exceptional returns, up 228% and 183% respectively, while the S&P500 was off 26%. The performance of the NCAV portfolio was a surprise, eeking out just a 5% gain over the period, which is nothing to write home about, but still significantly better than the S&P500.
The 10 stock portfolio’s returns are simply astonishing:
An original $100 would have become
- NCAV: $103
- NNWC: $544
- NNWC Incr: $503
- S&P500: $74
That’s a gain of over 400% for NNWC stocks!
Amazing stuff. It would be interesting to see a full academic study on the performance of NNWC stocks, perhaps with holding periods in line with Oppenheimer’s Ben Graham’s Net Current Asset Values: A Performance Update for comparison. You can see Jae Jun’s Old School Value NNWC NCAV Screen here (it’s free). He’s also provided a list of the top 10 NNWC stocks and top 10 stocks with increasing NNWC in the NCAV NNWC Screen Strategy Backtest post.
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I think much of the excess return of NNCW instead of NCAV investing is related to avoiding financial distress. In one of your papers you wrote financially distressed net-nets perform worse. I think you are absolutely right. So a long term study should not only look at the difference between NCAV and NNWC but also investigate which part of the difference is explained by avoiding distress.
There are fundamental reasons why this matters: for example when there is not much distress often inventory can be sold for book value, and then the probability of value destroying dilutions is lower as well.
For me it is easier to use NNWC than NCAV. But because I know distress matters I use ranking of the stocks from the screener (with NCAV/Market cap > 1.35). I rank among others on NCAV/Market cap and liquidity but also on financial distress. Click on my name to read the SeekingAlpha article explaining how to do this.
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[…] 19, 2010 by greenbackd Jae Jun at Old School Value has updated his great post back-testing the performance of net current asset value (NCAV) against “net net working capita… by refining the back-test (see NCAV NNWC Backtest Refined). His new back-test increases the […]
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tedk81 great points. I do love the excerpt from the Security Analysis.
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I’ve already said this on his site, but I have to disagree that this study proves anything- the assumptions going into it are flawed.
First, he charged only .5% for commissions and slippage (unsure if .5% a side or .5% total), and when dealing with these kinds of issues that pretty much never happens, 5-10% is not uncommon (as I’m sure you know)…. it’s quite possible that many stocks in the top 10 of this rolling list were completely untradeable due to ultra-wide spreads and/or thin markets.
Because of the crazy spreads rolling it over every four weeks would most likely have seriously hurt the returns we’re looking at here, especially if you are throwing any kind of money at this. Buying 1 share for a study is one thing, but say you put even a small amount into doing something like this, even at $5k per stock you’d be running into deep trouble, rolling it over every month would be suicidal…
On top of that there are serious sample size issues here. It’s such a short timeframe that it’s basically meaningless, and I’m pretty sure that if you looked at the last 25 or 30 years last year would have been one of the best years for net-nets in the entire period.
That’s ok anyways, we already have other studies (see Oppenheimer, James Montier’s put out some informal stuff, there is a paper on SSRN applying this approach the the LSE from 1980-2006 and there are other studies) and records of people using this approach since the time of Ben Graham. All studies aside, the net-net approach just makes sense to anyone with any kind of value background. What better way to get yourself in on companies that the market is so terrified to own that they sell for less than their NCAV? Ben Graham was brilliant.
I don’t want this to seem like I’m taking a swipe at Jae. His blog is one of my favorite value blogs and I bought his spreadsheets a long time ago and get tons of use out of them (and I recommend everyone buy them), and I appreciate the effort he put into this but I just don’t think this particular study shows much.
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