“It’s foolish to confuse value and price”. Antonio Machado
Who is Benjamin Graham?
Benjamin Graham (1894-1976) became one of the most famous investors in the twentieth century. He started his career in Wall Street when he was twenty years old and eventually founded the Graham-Newman Partnership. Considered the father of Value Investing, Benjamin taught his investment philosophy in Columbia Business School and wrote two books:
- Security Analysis, with David Dodd, in 1934.
- The Intelligent Investor, in 1944.
What was his investment strategy?
It is difficult to summarize Benjamin’s investment philosophy in a few sentences. Nevertheless, we can say that the author advocated the idea that common stocks don’t remain overvalued or undervalued forever, so investors can benefit from this fact.
In his first book, Security Analysis, he states that an intrinsic value can be calculated for the stocks by carrying both quantitative (balance sheet, profit & loss and Cash flow statements) and qualitative (management, industry’s key factors and catalysts) analysis. In his second book, The Intelligent Investor, the author mentioned two formulas that can help you to find possible intrinsic value for the publicly traded companies. One of them, is the following:
NCAV per share = (Total current assets – Total Liabilities) / shares outstanding
Following this formula, the intrinsic value comes from subtracting total liabilities from current assets and dividing the obtained quantity by the number of outstanding shares.
Benjamin Graham also remarked that an investor following this strategy should diversify his portfolio, because companies that trade below their NCAV per share are probably in trouble.
Backtesting the NCAV strategy: american markets.
When I finished reading The Intelligent Investor for the first time, I looked for a backtest for this strategy. The first reference I found on the internet was one carried by Oldschoolvalue.com .On this article, the study starts on January, 1999 where $100 invested by that date would have been converted into $1177,09 in December, 2017. This can be translated on annual 13,43% return. For the same period, the S&P 500 would have only provided an annual return of 6%.
Recently, after re-reading Graham’s books, I looked for more references about this strategy and I found an article. There, I discovered that Henry Oppenheimer, an American professor in New York, tested the NCAV strategy during the years 1970 – 1983. He selected the 31/12 as the date for replacing the holding stocks for those which were meeting the criteria. The results was an outstanding 28,2% anual return. This result was very good comparing to the index that produced an 19,6% annual return. Another author, Tobias Carlisle, on his book Deep Value run the same experiment for the period 1983- 2008. Since the experiment was exactly the same, the reader could think that the results should be approximately the same. In fact, the return was smaller than in the previous considered period: 22,4%.
Backtesting the NCAV strategy in Spain.
All those experiments were run for the american stock market, but I felt the curiosity (and obligation) to run a similar backtest for the Spanish stock market. I didn’t follow the same criteria, since I made the portfolio changes the first working day of June (I wanted to stay out the January effect). I started on June, 2007 and finished 11 years later:
The result I got is an annual return of 12,5% following the NCAV strategy. By the contrary, investing all the money in the Ibex 35, the annual return got would have been -8%:
This formula seems to give us a semi-automatic approach to successful investing. Nevertheless, I wouldn’t say that such strategy is suitable for all investors. The main reason, stated above, is that companies trading below its NCAV value are most of the time small ones, struggling business or even both attributes at once. Those facts can make this approach a highly volatile one and can make you fall in value traps.
I won’t say that such approach is pointless, either. We have seen that all backtests done so far provide a huge advantage over their reference indexes, but the investors should be aware of all possible risk and choose those investments that better suit their financial goals.