Ben Graham’s Net Nets: Seventy-Five Years Old and Outperforming

Tobias Carlisle

Eyquem Fund Management

Sunil Mohanty

University of St. Thomas

Jeffrey Oxman (corresponding author)

University of St. Thomas


The strategy of buying and holding “net nets” has been advocated by deep value investors for decades, but systematic studies of the returns to such a strategy are few. We detail the returns generated from a net nets strategy implemented from 1984 – 2008, and then attempt to explain the excess returns (alpha) generated by the net nets strategy. We find that monthly returns amount to 2.55%, and excess returns using a simple market model amount to 1.66%. Monthly returns to the NYSE-AMEX and a small-firm index amount to 0.85% and 1.24% during the same time period. We conclude by examining potential factors to explain the excess returns on the net nets strategy. We examine the market risk premium, small firm premium, value premium, momentum, long-term reversal, liquidity factors, and the January effect. Of the various pricing factors, we find only the market risk premium, small firm premium, and liquidity factor are significant. We also note about half of the returns are earned in January. However, inclusion of these factors still does not explain the excess return available from the net nets strategy. Thus, we are left with a puzzle.

Ben Graham’s Net Nets: Seventy-Five Years Old and Outperforming

Benjamin Graham first described his “net current asset value” (NCAV) rule for stock selection in the 1934 edition of Security Analysis. Graham proposed that investors purchase stocks trading at a discount to NCAV because the NCAV represented “a rough measure of liquidating value” and “there can be no sound reason for a stock’s selling continuously below its liquidating value” (Graham and Dodd [1934]). According to Graham, it meant the stock was “too cheap, and therefore offered an attractive medium for purchase.” Graham applied his NCAV rule in the operations of his investment company, Graham-Newman Corporation, through the period 1930 to 1956. He reported that stocks selected on the basis of the rule earned, on average, around 20 per cent per year (Oppenheimer [1986]).

In the seventy-fifth anniversary of the publication of Security Analysis, the NCAV rule continues to show considerable performance in generating excess returns. This simple method of handicapping data readily available from a company’s balance sheet generates a sizeable return: more than 20% annually. The returns are not explained by common asset pricing models. This anomaly indicates that application of the NCAV rule can identify underpriced firms in a systematic way. Furthermore, this profitability of this method continues to make it an attractive method of stock picking.

The academic interest in Graham’s method has been relatively sparse. Greenblatt et al. [1981], Oppenheimer [1986], and Vu [1988] have reviewed the usefulness of the NCAV rule. In his 1986 paper, Oppenheimer presented evidence showing the profitability of the NCAV method for 1970 to 1983. We picked up where Oppenheimer left off, updating the results to December 31, 2008, using Oppenheimer’s method of picking stocks.

As one can view the NCAV rule as identifying deep value stocks, called “net nets,” investigations of the NCAV rule fall into the literature about value investing and the long-run outperformance of value stocks over growth stocks. The value investing literature is large and growing. It is populated by such well-known work as Fama and French [1992, 1996, 1998], Lakonishok, Shleifer, and Vishny [1992, 1994] and many others. Chan and Lakonishok [2004] provide a review and update of the empirical data regarding the value investing premium. They demonstrate that, aside from the late 1990s, value stocks outperformed growth stocks and had lower risk. This phenomenon is not limited to the U.S.

The liquidation value of a firm, for which the NCAV criterion serves as a proxy, is the lowest measure of a firm’s value. Firms trading at a discount to NCAV are therefore deeply discounted. Following Fama and French’s interpretation of the value premium, these should also be very risky stocks, as the value premium compensates the investor for distress risk. Our work here indicates that this is not the case. In fact, the value premium is not a main driver of returns in the NCAV context. The market risk premium and the small firm effect do explain some of the returns, but the NCAV method generates high excess returns unexplained by any factor we have included.

Ben Graham's Net Nets

See full PDF here.