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How to Find a Bargain Stock

One of Benjamin Graham’s earliest analyses is the Net Current Asset Value approach.

How to Find Bargain Stocks

The Net Current Asset Value Approach

HQ Sustainable Maritime

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Everybody loves a bargain, but some bargains seem too good to be true. How can we figure out which bargains are for real, and which ones are not?

I rely on time-tested analysis to improve my odds: Analysis that relies more on a company’s history, than on unreliable predictions of future operation. I also look at the background and success of the person who devised the analysis.

There is no better analyst to turn to than Benjamin Graham, the father of value investing and the creator of the stock analyst profession. Mr. Graham created several investing methodologies, which are well documented in his most famous books: Security Analysis, co-authored with David Dodd in 1934, and the Intelligent Investor, which was first printed in 1949.

One of Benjamin Graham’s earliest analyses, created and tested 75 years ago, is the Net Current Asset Value (NCAV) approach. The objective of the NCAV formula is to find the minimum value a company would fetch if it was liquidated. The formula is:

Net Current Asset Value (NCAV) = cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) – total liabilities – preferred stock

The resulting value can then be divided by the number of common shares outstanding to find the NCAV per share. If the current stock price is less than the NCAV per share, the stock is a bargain. However, further analysis is necessary to determine if the company is prosperous.

Companies with earnings deficits or with erratic earnings histories are likely to become less prosperous and should be avoided. Companies in the financial sector should also be avoided, because their balance sheets are not comparable to those of other companies.

Finding profitable companies selling below their NCAV is a simple process. However, not many companies are selling below their Net Current Asset Values. I screened 9,000 companies and found only 12 companies selling below their NCAV. And most of the companies are not very prosperous.

Back in 2003, I used the NCAV formula to find bargain stocks, and in March 2003, 15 stocks clearly qualified. The number of qualified companies dwindled during the year until 12 months later, no stocks qualified. However, during the 12 months when some stocks qualified as bargains, the stocks tripled in price!

Most stocks that qualify as NCAV bargains are small companies, which usually are risky investments. However, Benjamin Graham surmised that any companies selling below their NCAV values carry lower risk: “They are indubitably worth considerably more than they are selling for, and there is a reasonably good chance that this greater worth will sooner or later reflect itself in the market price. At their low price these bargain stocks actually enjoy a high degree of safety, meaning by safety a relatively small risk of principal.”

When should you sell a bargain stock? Benjamin Graham held his stocks until a 50% gain was realized but no longer than two years. Mr. Graham also advocated investing in as many NCAV bargain stocks as possible. The more stocks you invest in, the more you can reduce your risk.

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As I mentioned, I applied the Net Current Asset Value formula to my database of stocks and found a few stocks selling below their NCAV values. One stock stands out, because the company is in an industry with great potential.

HQ Sustainable Maritime Industries (HQS) is a leader in the aquaculture industry in China. Aquaculture includes the farming of fish and aquatic plants in fresh water or ocean enclosures. The aquaculture industry supplies one-half of the world’s fish and shellfish needs. Aquaculture is the fastest growing segment in the food production system and has been for the past two decades. The primary objective of the industry is to produce healthy, nutritious fish for consumption.

HQ Sustainable Maritime is an integrated aquaculture and aquatic product processing company with operations based in the island province of Hainan, in China’s South Sea. The company’s aquaculture is conducted in fresh and salt-water areas that are pristine and free from pollutants such as mercury and plastic trash. In addition to raising and harvesting fish, HQ processes and sells fish and fish products including tilapia, shrimp, squid and red snapper.

HQ Sustainable Maritime is China’s largest exporter of tilapia and commands 10% of the tilapia market in the U.S. Tilapia is a popular name for numerous freshwater fish originally native to Africa. Tilapia is easy to farm, mild in taste and rich in protein.

The company produces and sells Lillian’s Healthy Gourmet Meals and other fish products in the U.S. The company has cold storage facilities and aquatic product processing facilities in Hainan. In addition to headquarters in Seattle, the company has operational offices in Wenchang, Hainan.

HQS’s sales have grown steadily from $27.5 million to $72.3 million in 2009. Earnings per share (EPS) were $0.54 in 2007, $0.78 in 2008 and $0.60 in 2009. EPS are expected to advance to $0.85 in 2010 and then $1.00 in 2011.

At the current price of about 4.50, HQS shares sell at a discount to their NCAV of 5.13 and book value of 7.75. The current price-to-earnings-ratio of 7.5 is cheap, although the company does not pay a dividend. HQS shares trade 133,000 shares daily from a market capitalization of $66 million. I recommend buying HQS at or below 5.13 and sell when the price reaches 7.70.

Sincerely,

J. Royden Ward
For Cabot Wealth Advisory

Editor’s Note: You can read more about Ben Graham’s other investing methods in the Cabot Benjamin Graham Value Letter. I expect to feature NCAV bargains in future issues. Don’t miss out on my next NCAV recommendations. Click here to get started today!

http://www.cabot.net/info/bgv/bgvkr02.aspx?source=wc01

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J. Royden Ward has spent his entire career seeking strong investment returns for his clients while keeping risk low. In 1969, he developed a computerized model of stock selection based on formulas created by investment legend—and Warren Buffett mentor—Benjamin Graham, and since 2003, he’s been spreading his wisdom far and wide as chief analyst of Cabot Benjamin Graham Value Investor.