NCAV/MV in Thailand Stock Market Part 3

This individual study is base on the research paper called “Testing Benjamin Graham’s Net Current Asset Value Strategy in London” by Ying Xiao and Glen C Arnold. The authors illustrated the return from portfolio using net current asset value strategy is more than return from market index. The main paper concluded that 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 Benjamin 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. 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 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’ 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. However, Graham reasoned that the majority of these value stocks will survive and produce good returns because of the potential for one of a number of developments to occur preventing management from continuing on a path of value destruction through the gradual dissipation of assets:

·         Earning power would be lifted to the point where it was commensurate with the company’s asset level. This could come about in two ways: a general improvement in the industry – entry and exit dynamics mean that low industry profitability is frequently not as persistent as many market pessimists believe - and; a change in the company’s operating policies – management running a company with such a low stock price relative to assets either respond voluntarily to take corrective action or they (or their replacements) are forced to by stockholders, such as adopting more efficient methods or abandonment of unprofitable lines.

·         A sale or merger with another corporation that could employ the firm’s assets would take place. It would pay at least the liquidation value.

·         Complete or partial liquidation could release value. The management of a corporation selling at below liquidation value need to provide a frank justification for continuing to operate.  

The objective of this paper is to study NCAV/MV strategy in Thailand since I am not aware of any work done on the Thailand stock market. However my individual study does not follow all step of original the research paper due to some limitations. This individual study does not use the criteria that stocks in portfolio must have NCAV/MV greater than 1.5 because there are only few stocks which can pass the criteria so that it cannot be the good sample size. These individual study the criteria that stocks in portfolio must have NCAV/MV greater than 1.0 instead. This individual study also not apply Fama and French (three-factor pricing model) model because there are some researches that apply Fama and French model in Thailand Stock exchange and the result show that it cannot clearly explain fundamentally riskier in Thailand Stock market. The results of this individual study not exactly the same as the original paper by the way it shows the trend that NCAV/MV strategy could be applied in Thailand stock exchange.