Price is what you pay, value is what you get. Believe it or not, hidden in the depths of the stock market can be companies that are selling for less than the value of their current assets.
More remarkable still is the fact that if you deduct all liabilities, both long- and short-term, from these current assets you can still find some companies are selling for less than this net current asset value.
This is even more astonishing if we consider that we have completely ignored the value of the long-term assets (non-current or fixed assets). They are valued at zero in this approach.
This is conservative valuation taken to an extreme. It may be that the long-term assets comprise of buildings, vehicles, plant, etc., with a significant market value and yet we ignore all of that – we count it at zilch.
Two more layers of caution
So in Net Current Asset Value, NCAV, we take current asset values only and deduct all liabilities. But before we compare that with the market price there are yet another two layers of conservatism.
We do not take the current assets valuation number in the balance sheet at face value. It could be that you want to build in a margin of safety on the inventory valuation. Perhaps you want to allow for managers being too optimistic in their estimation of what they can sell partly-made or finished goods for. Perhaps you only value it at 66% of the BS value.
Similarly with receivables (‘debtors’ in old money); the managers may be more optimistic than you in guessing the proportion of customers who will not pay. Perhaps the receivables figure should be lowered by 20%.
We must ensure that the qualitative characteristics of the company are sound. This falls under three categories (1) Prospects for the business, (2) Quality of management, (3) Financial stability. These will be looked at in a future blog.
The next blog considers what leads to such lowly priced shares. After that I describe what might cause these highly neglected companies to generate high returns for shareholders in the future. After all, they have usually displayed large share price falls in the recent past and are often unprofitable