Asset Based Analysis: Does It Work?

| September 30, 2016

Asset based analysis is one of the oldest and most fundamental ways to determine the intrinsic value of a stock.

Benjamin Graham strongly advocated for this approach in his 1934 book, Security Analysis.

Furthermore, Graham consistently invested in stocks using asset-based analysis throughout his six decade career.

The question is, does it still work?

Relevant or Irrelevant?

Today, many analysts argue that asset based analysis is outdated and no longer relevant. They say it’s not enough just to account for a company’s assets and liabilities.

According to them, factors such as profitability, growth, and a competitive advantage far outweigh the importance of what a company has on its balance sheet.

I disagree. Those who ignore the value of a company’s net assets when evaluating the stock price are missing out on finding tremendous value investment opportunities. Asset based analysis has stood the test of time as a wonderful way to find discrepancies between a stock’s price and value.

Here’s an overview of what asset based analysis is and some recent examples where it uncovered investment opportunities which went on to provide phenomenal returns.

What is Asset Based Analysis?

A simple and common way to value a business is to examine the strength of its balance sheet. This is considered asset based analysis.

Balance sheets provide a snapshot of a company’s financial position by breaking down its total assets and total liabilities. When investors focus on a company’s financial status, they know exactly what they are buying and are able to avoid making assumptions.

The key advantage to asset based analysis is that net asset values are relatively stable. They do not drastically change from one quarter to another and they typically only experience gradual adjustments throughout a business cycle.

The one limitation is that assets and liabilities are accounting figures which are subject to inexact measures and can easily be manipulated by dishonest managers.

Key Ratios

Book value per share is the most commonly used type of asset based analysis for finding undervalued stocks. Book value is the sum of a company’s net assets after accounting for all liabilities.

In theory, it is the net worth owed to shareholders if a company were to stop operating, which is why it’s also referred to as “shareholder’s equity.”

Because book value calculates an asset’s value using historical cost less depreciation and includes intangibles such as goodwill, more stringent metrics are often used in its place.

For example working capital is the amount left over after subtracting all bills due within one year (current liabilities) from any asset that can be converted into cash in the same one-year period (current assets).

Benjamin Graham wrote extensively about two approaches in particular: net current asset value (NCAV) and net-net working capital (NNWC).

Both of these methods calculate a stock’s intrinsic value by subtracting all liabilities from a conservative estimate of current assets.

A Case Study: GEOS

At the end of November, 2015, I wrote an article on Seeking Alpha making a case that Geospace Technologies (GEOS) provided a great value investment opportunity.

I argued that because its current price was lower than my calculation of its liquidation value, there was a large margin of safety. At the time, an investment in GEOS had huge upside potential with little downfall.

My analysis was strictly quantitative. Before writing the article I had never heard of GEOS. I found GEOS using a simple stock screen that showed its net asset value was higher than its stock price.

While the content of the article focused heavily on the data, there was some mention of the company’s future prospects and the state of its industry. I considered this information to be fluff and added it solely to satisfy the editors at Seeking Alpha.

When the article was published, the response I received from readers was overwhelmingly negative. Although the comments were all respectful, almost everyone disagreed with my method of analysis and my conclusion that GEOS had the potential for huge returns.

Here’s some of the feedback I got:

  • Despite what the author of this article thinks I believe this ticker is dead money.
  • Geospace has a lot of potential, but I don’t think the approach used here is the way to assess it.
  • I don’t see the light at the end of the tunnel here.
  • Liquidation value argument holds when company is in actual liquidation. At best this is a momentum stock. If you’re a momentum trader watch out for this name. If not, just ignore.
  • Inventory will have to be written down and there might not be any future profits if oil doesn’t recover.
  • Liquidation value doesn’t apply here, because the company won’t liquidate.
  • You may be correct that demand for exploration products comes back when crude prices rebound, however, that doesn’t necessarily mean GEOS will be participating in that recovery.

I countered all of these arguments by saying that the company’s strong balance sheet and low stock price – as measured against its net assets – make any further analysis irrelevant.

Here is a response I gave one reader who felt that without a quick increase in new contracts GEOS was dead money:

The current price of the stock allows for huge upside IF things turnaround. If things do not turnaround, the loss will not be huge because the market is already factoring a worst case scenario into the stock. Investors who own GEOS in a diversified portfolio and are willing to wait out the uncertainty could see a return many times over.

Although the return isn’t yet many times over, the share price of GEOS is up nearly 35% from where it was when I wrote about it. At one point in June, the stock was at a 65% increase from when the article was written.

Another Case Study: NCAV

More recently, I wrote an article advocating for five stocks all meeting Benjamin Graham’s criteria for the NCAV strategy. The purpose of this simple article was to merely state that each of the stocks met the strategy’s criteria.

I mentioned that investing in a basket of such stocks should provide good returns.

The responses were again skeptical to say the least. Here are some of the comments:

  • These appear to be penny stocks on the way downhill, with an upside potential – maybe – of unknown time frame.
  • The problem with these five stocks are, of course, the market thinks they’re all Chinese frauds. I’d love to hear some ideas that aren’t headquartered in that particular country.
  • Maybe there is a reason these are “bargains”. All are suspect. Never again. And you can wait out MSN as it slides to zero.
  • Many companies that sell below NCAV spiral down because they lose money every quarter. They remain “bargains” because their stock price decline faster than their NCAV. These nasty companies exist to cater to the employees and executives – not to shareholders.

This article was published on July 13, 2016. If an investor would have invested an equal amount in each of the stocks I wrote about on that day, they would currently have a 95% gain.

Here is the breakdown on each stock as of close on 9/23/16:

  • NVFY: +330%
  • SORL: +116%
  • MSN: +62%
  • CGA: +11%
  • ALN: -45%

Group Outcome

The great thing about following systematic investment strategies such as NCAV is that it doesn’t matter if one or a few of the stocks go bust. The group performance is all that matters.

Furthermore, it’s important to note that investment strategies using asset based analysis only work when investing in a basket of stocks. There is no guarantee that any individual investment will be profitable just because it meets the standards of a particular strategy.

Here’s what Benjamin Graham said about the NCAV strategy late in his life:

[This] 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… 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.

Graham’s foolproof method and other asset based techniques still work today. They are simple but definitely not easy.

Any stock that looks cheap compared to the company’s assets are out of favor for a reason. Average investors will find all kinds of excuses to stay away.

Disciplined investors, on the other hand, will have no problem investing and waiting for things to turn around.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.


Note: The author of this article is Mitchell Mauer. He is a contributor to

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Category: Stocks

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The author of this article is a contributor to ValueWalk is your everyday source of breaking and evergreen news on everything hedge funds and value investing.

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