In the introduction to this article series, I explained that value investing is about identifying differences between a business’s fundamental value and the market price offered to own shares in it. The simplest way to view that fundamental value is by analysing the balance sheet, particularly a business’s Net Asset Value.
Asset-based investing
Net Asset Value (NAV) is also known as Book Value. For example, on the Stockopedia StockReport:
Or Total Equity in a set of accounts:
NAV is calculated by taking the total assets on a company’s balance sheet and subtracting the total liabilities. It can be thought of as what the company believes it would receive if it sold off all its assets and paid off its liabilities.
Net Asset Value (or Book Value or Total Equity) = Total Assets – Total Liabilities
Unfortunately, it is doubtful that shareholders would receive such value in a liquidation situation. Book value also includes the value of intangible assets, such as goodwill (which arises when a company acquires another company for more than its book value) or capitalised development expenditure. Although sometimes very valuable to the company, these intangible assets may not be worth anything to someone else. For this reason, many value investors choose to look at Tangible Book Value instead, also known as Net Tangible Asset Value, which excludes those intangible assets in the calculation.
Net Tangible Asset Value (or Tangible Book Value) = Total Assets – Intangibles – Total Liabilities
Even companies trading at a discount to Net Tangible Asset Value may not always be profitably liquidated. The value of inventories will vary depending on whether they are raw materials or finished goods and the demand for those goods. The value of receivables will depend on whether they are billed or unbilled and if customers have a habit of paying on time. In general, it is better to find a company with significant cash balances and freehold property with alternative use value. Even then, the costs of liquidating a company can also be high enough to erode any profits that would be made.
However, there is another reason to invest in companies trading below tangible book value: it implies that these assets are currently unproductive. In such cases, managements face pressures to improve their efficiency, reduce their working…
