Testing Ben Graham’s NCAV Strategy in London

Ying Xiao

University of Salford

Glen Arnold

University of Salford


It is widely recognized that value strategies – those that invest in stocks with low market values relative to measures of their fundamentals (e.g. low prices relative to earnings, dividends, book assets and cash flows) – tend to show higher returns. In this paper we focus on the early value metric devised and employed by Ben Graham – net current asset value to market value (NCAV/MV) – to see if it is still useful in the modern context. Examining stocks listed on the London Stock Exchange for the period 1981 to 2005 we observe that those with an NCAV/MV greater than 1.5 display significantly positive market-adjusted returns (annualized return up to 19.7% per year) over five holding years. We allow for the possibility that the phenomenon being observed is due to the additional return experienced on smaller companies (the “size effect”) and still find an NCAV/MV premium. The profitability of this NCAV/MV strategy in the UK cannot be explained using Capital Asset Pricing Model (CAPM). Further, Fama and French’s three-factor model (FF3M) can not explain the abnormal return of the NCAV/MV strategy. These premiums might be due to irrational pricing.

Testing Ben Graham’s NCAV Strategy in London – Introduction

The interpretation of the excess returns to value strategies is controversial and has been explained in two ways. First, the excess return associated with value stocks is due to the propensity of value portfolios to be disproportionately small firms, and so what is really being observed is a low market capitalisation effect. Second, value strategies are fundamentally riskier. For example, Fama and French (1993, 1996) created their three-factor pricing model (market factor, small minus big size factor and high minus low book-to-market factor) in an attempt to provide a risk compensation explanation of value premiums. However, many other researchers, particularly behavioural finance adherents, dispute whether the FF3M really measures risk induced equity return premiums. According to this view high returns to small companies and high returns to low market-to-book ratio companies are caused by investors being less than completely rational, leading to neglected, under-researched stocks and temporary under-pricing, followed by a convergence to intrinsic value.

Amongst the array of value strategies the net current asset value (NCAV/MV) approach has been successfully used in practice, most famously by Ben Graham in the early twentieth century, bringing high profits from the 1930s to 1956. There have been very few studies examining the NCAV/MV strategy. Ben Graham’s NCAV/MV strategy calls for the purchase of stocks at a price 2/3 or less of the NCAV. Per share NCAV, as defined by Ben Graham (Graham and Dodd (1934), Graham (1976)), is the balance sheet current assets minus all the firm’s (current and long-term) liabilities divided by the number of shares outstanding. Long-term assets (e.g. intangible assets and fixed assets) values are not counted. Graham found that companies satisfying the NCAV/MV strategy were often priced at significant discounts to estimates of the value that stockholders could receive in an actual sale or liquidation of the entire corporation. Thus, the NCAV/MV rule, in theory, not only protects capital from significant permanent loss but also generates a portfolio of stocks with excellent prospects for advance in price.

‘It is clear that these issues were selling at a price well below the value of the enterprise as a private business. No proprietor or majority holder would think of selling what he owned at so ridiculously low a figure…In various ways practically all these bargain issues turned out to be profitable and the average annual result proved much more remunerative than most other investments’ Ben Graham (2003). An adherent to the efficient markets hypothesis would advance the argument that investors rationally push down a stock’s price to below NCAV in anticipation of the corporation continuing to invest its resources in wasteful ways, gradually draining the company of much of its shareholder wealth.

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Ben Graham NCAV Strategy