Valuing The Market Based On The Number Of Net-Nets?

Valuing The Market Based On The Number Of Net-Nets? via SG Value Investor

Many are familiar with market valuation indicators such as trailing, median P/E ratio, P/B and dividend/price ratio. In this article, I am not explaining the use of such indicators but wanted to introduce one that is relatively not known to many these days. Personally, I only found out about it recently, given my preference of using the long favored market valuation ratio, one even Warren Buffett pointed out to be ‘probably the best single measure of where valuations stand at any given moment.’ That would be the ratio of Total Market Capitalization to US GDP (TMC/GDP), which would stand at approximately 1.241 as of today, indicating that markets are significantly overvalued.

Everyone would be familiar with the term ‘Net-Net’ coined by the great Benjamin Graham, which just means to a company being priced below the value of its current assets less all liabilities. While we understand the implications of a company being a net-net, what are the implications when used on a market level?

Based on research done, just from the number of net-net companies compared to the S&P 500 Return, we are able to have a feel of the valuation of the market.

Seth Klarman: Investing Is Art First, Craft Second And Science Third

Seth KlarmanSeth Klarman is considered to be one of the best value investors of all time. Unfortunately, he does not give many interviews or lectures. Q2 2020 hedge fund letters, conferences and more Luckily, those interviews and speeches that he does give are stuffed full of information and highly insightful comments that value investors can learn Read More


 

From the research conducted by Graham Theodore & Co. Ltd., we are able to observe the inverse relation between the number of net-nets in the market and the S&P 500 Return. The greater the number of net-nets, it would indicate a more bearish market, with market valuations on the low side and vice versa. With that said, looking at the current market today (NYSE MKT LLC, NYSE, NASDAQ) there are only a total of 59 net-net companies and the average annualized returns from 2012 to present would be approximately 21%. Compared to the initially mentioned TMC/GDP ratio, it would indicate that market valuations are indeed overvalued.

Looking at past history, the highest point TMC/GDP ever reached was 1.48 during the technology bubble in 2000. What does it mean for us going forward now? I am not saying that we should all start winding down our portfolios and sit on cash, however, it would be best that we hold a larger proportion of our portfolios in cash and consider realizing profits for companies nearing their fair value.

Previous articleValuing Yamana Gold Inc. (AUY)
Next articlePrivate Employment: Extremely Positive Trend Continues
I developed my passion for investment management especially equity research at a relatively young age. My investment journey began when I was 20, at a point in time where markets were still recovering from the Global Financial Crisis. My portfolio started from money I saved over the past years and through working during the holidays. I was fortunate to have a good friend with common investing mentality to began my journey towards value investing. To date, we still research and invest in companies together, discussing valuations and potential risks of a company. To date, I manage a fund with a value investing style. Positions are decided upon via a bottom-up approach or smart speculation (a term I came up with when buying a stock for quick profit due to a mismatch in prices in the market due to takeovers/selling of a subsidiary or associate). Apart from managing my own portfolio, I enjoy sharing my research with family and friends, seeking their opinions and views towards the stock. Reading Economics in London, I constantly keep up with the financial news in Singapore & Hong Kong. Despite my busy schedule, it has not stopped me from enjoying other aspects of life. I enjoy a variety of activities in whatever free time I may have – endurance running, marathons, traveling, fine dining, whiskey appreciation, fashion. Lastly, I enjoy meeting new people, discussing ideas and gaining new perspectives towards issues in the world.