The table below is a summary of various studies that analyzed the performance of Benjamin Graham's stock filtering criterion of purchasing stocks trading below net current asset value (NCAV). The calculation involves subtracting all liabilities, including preferred stock, from only the current assets on a company's balance sheet. The calculation is then converted to a per share figure by dividing this approximate measure of a company's liquidation value by the total number of common shares outstanding. The table below picked through each study and pieced together a sampling of the performance data using the net current asset value criterion.
Each study summarized in the table varied in terms of the amount of historical stock data that were analyzed. The amount of data used across studies ranged from as little as five years to as long as 60 years. Some time periods resulted in a large number of NCAV stocks available for purchase; other times not so many. When few stocks could be found meeting Graham's stock filtering criterion, there were variations in how idle funds were used when tabulating the portfolio return statistics. Some studies omitted years in which few stocks could be found; other studies assumed a portion of the portfolio sat idle at a zero percent interest rate or a low U.S. Treasury Bill rate of return. The stock filtering criterion used in the various research studies ranged from highly selective, using Graham's original criterion of only choosing stocks trading at a price point below two-thirds of their NCAV to as high as parity with the trading price of a stock. There also were variations across each study in terms of how often new stocks could enter the value investing portfolio -- from as often as every month to as infrequently as every five years. Timing the entry date when a new stock was included in the value portfolio varied across the research papers. Some studies assumed that new stocks entered the value portfolio at fiscal year-end, timing the purchase date to coincide with the exact same date when updated accounting data were available for review. Other studies assumed a lag time of as long as a year after the NCAV calculation was made before a new stock could enter the value portfolio. There also were differences across each study in terms of the length of time a deep value stock remained in the portfolio, ranging from as short as a few months based on the rate of return generated to as long as five years. Other distinctions across each study included the particular stock database used and whether transaction fees and dividends were included in the net return calculation.
A review of the table clearly shows that regardless of the differences in study methodology, a general theme emerges that stocks meeting Graham's net current asset value criterion outperform a broad market average. Given these stellar performance numbers, one might wonder why the masterminds on Wall Street haven't created financial products that replicate this stock selection filter. The answer I pointed out in a previous blog is its lack of scalability. Monster-sized funds with billions of dollars under management cannot implement this stock selection approach using such a rigorous stock selection criterion. Graham's deep value screening criterion eliminates too many stocks from the universe of choices. The amount of money needed under management for the fund to be profitable and the extreme selectivity of the filtering criterion are incompatible from a business model standpoint.
Does the NCAV approach to stock selection also work for international markets? The academic evidence is more limited, but a similar conclusion can be drawn showing the superior performance of the stock selection filter in both Japan and England.
Return calculations highlighted on the table were annualized and compared to a large-cap index referenced in each of the two international studies. The average annual portfolio return for those select NCAV stocks listed on the Tokyo and London Stock Exchange exceeded a matching international stock benchmark by a significant margin. Comparing international studies is imperfect because of the differences in accounting rules followed in each country. American investors also face additional currency risk after international portfolio returns are converted back to U.S. dollars. There were variations in the two international studies in the amount of historical data analyzed and how rigorous the entry criterion was for an NCAV stock to enter the value portfolio. As in the studies using only U.S. domestic data, there were variations in terms of the amount of lag time when a stock entered the value portfolio and when the calculation was made using the latest accounting data. The study analyzing Japanese stocks found no material difference in portfolio return when either a lag time of zero or two months was used after the latest accounting data became available to make the NCAV calculation.
The study using data from the London stock exchange used a lag time of six months from when accounting data became available. The NCAV stock filtering criterion used on Japanese stocks was less demanding relative to the stocks analyzed on the London exchange. Stocks listed on the Tokyo exchange that traded as high as parity with NCAV could enter the value portfolio. The study reviewing stocks listed on the London exchange followed the same buying criterion that Graham used in his original writings: at a price point below two-thirds of its NCAV calculation. As in the studies focusing on the U.S. stock market, stocks that met a version of Benjamin Graham's NCAV criterion resulted in above-market performance. Regardless of differences in study methodology, the evidence shows a greater average return for NCAV stocks in comparison to an international benchmark index on both the London and Tokyo exchanges.
A review of the studies testing Graham's NCAV stock filtering criterion has shown continued superior performance long after Graham first published his investment approach in 1934. The evidence shows that investors who have the discipline to follow Graham's teachings over the long run should continue to reap the benefits of using this highly selective value investing approach to stock selection.