Benjamin Graham liked cheap stocks. He especially liked stocks that sold below their net current asset value. Why?
Let’s say you own a small, neighborhood bar. You have a few regular customers, can get a good crowd if you can find a decent band to play on Saturday night, and despite the ups and downs, the bar generally brings in enough money to pay the bills. But would you sell if someone came in on a slow night and offered to buy it for less than the value of the cash in the register and the bottles of liquor on the shelf? The answer is no, unless you were a very desperate seller.
The stock market often prices companies below the value of cash, inventory, and receivables, minus debt- aka net current asset value (NCAV). Graham liked to buy a diversified basket of these companies he called “net-nets” at 66% of NCAV.
In today’s market, it is difficult to find values that cheap, especially those that are not fraudulent or in risk of going out of business. You should look at the cash flow statements and balance sheets to find companies that have a history of positive operating cash flow. It also helps to see what the insiders are doing. I like to see management owning a high percentage of stock.
I recently scanned a list of NCAV stocks and found three companies for further research.
Performance Technologies (PTIX)
PTIX manufactures networking and signaling equipment for telecom companies, with Alcatel-Lucent, Raytheon, and Leap Wireless among its largest customers. PTIX shares fell from the mid-teens in 2003 to $1.88 today primarily because it competes in a crowded industry constantly disrupted by technology changes. Don’t let the poor performance fool you. PTIX has a history of positive cash flow as recently as Q1 2010. With $1.66 per share of cash, the company currently trades at 85% of its $2.20 NCAV and 15% of the shares are held by insiders.
Vicon Industries (VII)
Vicon manufactures security cameras and video systems for use in office parks, schools, and prisons. VII has weathered the storm in a heavily cyclical business, showing positive cash flow in Q4 2010. The company caught the eye of other value investors and rose from a September low of $3.60 to a recent $5.00. With a whopping 40% insider ownership, the company still looks attractive selling at a discount to its NCAV of $5.75.
VOXX, an electronics company best known for its consumer audio products sold under the RCA and Jensen brands, is a perennial NCAV candidate. With a market cap of $189M, it is much larger than most NCAV companies. Things may be looking up for the company as operating cash flow has been up for the last two years and should continue to increase in fiscal 2010. Famed value investors Seth Klarman and the Kahn Brothers are major holders of the stock, though Klarman has been a seller as of late. VOXX sports a rising Piotroski score and 10% insider ownership, along with its NCAV of $9.63 versus its current price of around $8.26.
These companies are far from perfect. Each one boast several risks and compete in very difficult industries. Managing the risks are key. But remember when digging for “net-nets”, we aren’t looking for the next Arcade Fire. We’re just looking for a decent bar band that can bring a few dollars in the door while waiting for the overall market to get cheaper.