Is the Stock Market Expensive? Use Graham’s NCAV Method to Find Out
(Update: a follow up article has been published detailing the number of net nets in any given year to determine when the market is cheap.)
Measuring and gauging the stock market value is important.
Funny coming from a “value” guy like me because what the market does shouldn’t matter.
But before you call me a hypocrite and shut down this article, hear me out.
I like to relate investing with concepts from daily life. It puts things into perspective and context. Money and seeking profits has a way of clouding up common sense and numbing danger signs. Something that I am all too familiar with.
The reason for bringing this up is because you don’t want to fall into measuring and seeking vanity metrics like Liquidity Services (LQDT). One of their key performance indicator is to count how many people create an account on their site.
Useless because it’s a lone indicator without relation to anything. That’s why financial metrics are a combination of two or three different numbers to put things into perspective.
Measuring the Right Things Help You Move Forward
A couple of years ago I made a goal to work out and put some meat on my skinny frame. The first thing I did was measure my starting weight.
In order to achieve my goal, I needed to know my starting point to formulate a plan and stick to it.
Same reason why you take annual health exams. It helps you gain a better understanding about your body and what to do going forward.
It’s no different for your portfolio and the market. I try to get a sense of stock market valuation to determine how to proceed. To come up with a game plan.
- Where do I see myself in this market?
- Is my portfolio constructed with enough margin of safety?
- How much cash should I be holding?
- Is it time to just sit back, read, write and learn instead of trying to find a cheap stock everyday?
To answer any of these questions, there has to be a starting point, and the starting point for any portfolio is always in relation to the stock market value.
If you are like me, your portfolio goal is not as clear as it should be. Trying to beat the market or achieving the best possible return isn’t a goal.
It’s a want.
How do you get the best return in a rising market? How do you beat the market in a crashing market?
Notice how putting things into context makes the same thing look brand new.
Determining the Stock Market Value with Net Nets
I don’t have any fancy financial models to calculate the value of the market. I don’t look at corporate earnings, GDP or other economic factors to try and predict whether there is more room to grow. In fact, I don’t understand everything about the economy, and I don’t try to.
Instead, I measure the market using Graham’s simple net net principle. It’s designed to provide only one clear signal.
The market is cheap, or it isn’t.
Important point here is that I did not say expensive or overvalued. Just not cheap.
Net net stocks are dirt cheap stocks. The more there are, the cheaper a market is. If net nets are hard to come up, the market is not cheap.
No rocket science here. Just a simple way to measure the temperature of the market.
Where the Market is at the Moment
I’ve pulled up a list of stocks trading for less than NCAV via portfolio123 and right now there are 72 stocks priced below NCAV.
Out of 72, 29 are OTC stocks and 5 are Chinese stocks.
That leaves just 38 net nets existing today in the universe of 6000-7000 stocks on the national exchanges.
It’s clear that the stock market is not cheap.
38 NCAV Net Net Stocks in a “Not Cheap” Market
The other benefit of pulling up a list of net nets to determine the value of the stock market is that you get to look at some cheap ideas.
If you follow net nets, you’ll recognize a lot of the names below. You can download the spreadsheet which includes the stock price, market cap and NCAV.
I’m no Robert Shiller, but at least Graham would agree with me that the market is not cheap.