Testing Benjamin Graham’s Net Current Asset Value Strategy in London

Abstract

It is widely recognized that value strategies—investing in stocks with low market values relative to measures of their fundamentals—tend to show higher returns. This article focuses on the early value metric devised and employed by Benjamin 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 U.K. cannot be explained using the capital asset pricing model. Further, Fama and French’s three-factor model cannot explain the abnormal return of the NCAV/MV strategy. These premiums might be due to irrational pricing.

TOPICS: Performance measurement, factor-based models, factors, risk premia