99.9% of Stocks Won’t Pass This Test

October 13, 2023

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– Amanda Heckman, Editorial Director

Few individuals have left a bigger mark on the financial world – or my way of thinking as an investor – than Benjamin Graham.

He not only pioneered fundamental analysis but also achieved great success through value investing. Today, many of the world’s most successful investors – including Seth Klarman, Joel Greenblatt, Charlie Munger and Warren Buffett – swear by Graham’s insight and credit his methods for their great success.

From 1936 to 1956, Graham and his business partner Jerome Newman ran an investment firm called the Graham-Newman Corporation. In those 20 years, they achieved 21% annual returns using Graham’s methods, outperforming the S&P 500’s 12% return.

So what was Graham’s great insight?

Buy stocks priced below their real value.

Simple, right? Not so fast.

As the aforementioned Seth Klarman notes in his book Margin of Safety, “Any attempt to value businesses with precision will yield values that are precisely inaccurate.”

So how do you go about finding real bargains in the market?

Here are two strategies I use…

Take a company’s current assets and subtract its debts. If the company’s market value is much less than this figure – its liquidation value – then the business could be bought for pennies on the dollar.

Of the 1,500 companies in the S&P Composite 1500 Index, just two meet this strict criterion today. (They’re both small cap stocks, one a biotech and one a pharmaceutical.)

That disqualifies 99.9% of companies.

A less strict method? Look at a company’s net asset value (NAV) – that is, its total assets minus its total debts – instead of its liquidation value.

Around 140 companies in the S&P 1500 have market values that are 20% or more below their NAV.

Most of them are small caps.

I’ve long argued that most stocks are overvalued. But compared with the large cap market, the small cap market holds much greater potential for value-conscious investors.

In fact, the undervalued small caps among the 140 companies I mentioned above trade at a greater discount than their peers.

As Manward’s own Speculative Assets Specialist Robert Ross says, “The smallest stocks offer the greatest potential. They are risky, but these risks are smart. [These types of stocks] could easily grow your money exponentially.”

When you combine the explosive long-term potential of small caps with the discipline to buy them at deep discounts, you’ve got a winning strategy.

One that even Benjamin Graham could be proud of.