Deep Value Index Posts Strong Outperformance Vs. Nasdaq During COVID-19 Pandemic

It has not been easy being a value investor over the last ten years. Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) has lagged the Nasdaq by almost 400% since the beginning of 2010. It is hard to pinpoint the exact reasons for this divergence in results, however, my view is that low interest rates globally have been an important factor, since when long-term yields decrease, growth stocks (with higher estimated cash flow durations) will necessarily outperform.

Source: Seeking Alpha, Author analysis.

Instead of comparing Berkshire with Nasdaq, we can also compare ETFs tracking Value and Growth stocks more generally. Below I show the relative performance development between the iShares Core S&P U.S. Value ETF (NASDAQ:IUSV) and the iShares Core U.S. Growth ETF (NASDAQ:IUSG). During the last ten years, by this measure, Growth outperformed Value by broadly 150%.

Source: Seeking Alpha, Author analysis.

Going into the Covid-19 Pandemic, my view was that Value would outperform Growth, since down-revisions of future growth would hurt Growth stocks relatively more than Value stocks.

This has not been the case, instead, my expectations were utterly crushed by the 25% differential between Growth and Value as shown in the graph below. It is of course hard to explain exactly what has caused this divergence, however, my view is that lower long-term yields and the stay-at-home tech play have been the two main drivers.

Source: Seeking Alpha, Author analysis.

So is there anyplace value investors can go and find alpha – is there anyplace in the market where Value beats Growth?


In my search for this alpha, or more generally to find a place to earn acceptable returns, without risking my capital on high-flying tech stocks. I went back in time and reviewed the original scripture of value investing.

In the scripture, author Benjamin Graham stated that it was possible to achieve market-beating returns by investing in companies below their liquidation value (“Net-Nets”).

The rationale for this out-performance was according to Graham:

“there can be no sound reason for a stock’s selling continuously below its liquidating value” and the stock is then “too cheap, and therefore offered an attractive medium for purchase.”

Of course, Graham conducted his original research during the great depression, and global financial markets have evolved beyond recognition since then, but relatively recently, modern financial research confirmed that during 1984-2008, Net-Nets as a strategy outperformed the market by a wide margin.

Since this research was performed up to 2008, I decided to create my own Net-Nets index and track this index over time. The three questions that arise, when trying to create such an index is (1) how should liquidation value be defined, (2) what additional screens if any should be implemented when constructing the index, and (3) what should the index turnover frequency be?

Liquidation value

There are different methods of measuring liquidation value, and they have different effects on the subsequent composition of an index tracking stocks trading below their respective estimated liquidation values.

In the index I have created, I use a simple measure based on the difference between Current Assets (as reported in a given company’s last quarterly statement) less Total Liabilities (giving no value to long-term fixed assets). This measure is called Net Current Asset Value (“NCAV”). I then divide this measure by fully diluted shares outstanding and compare this NCAV per share measure with the stock price of a given company at index rebalance date.

Another liquidation measure (used by Graham) involves using a range of impairments across balance sheet asset types. So, instead of recognizing Current Assets reported by a given company in full, only Cash is non-impaired. While receivables are recognized by 75-90% of their stated value, inventories by 50-75% and fixed assets by 1-50% (average 15%).

Additional screens

Based on the NCAV measure, I use a database (data provided by Morningstar) and screen all stocks listed on US public markets (except OTC markets). Of the 5269 stocks available in this database (21 July 2020), only 71 stocks pass the NCAV filter. One important point is that I include all stocks trading below NCAV, and I don’t use some margin of safety to this measure. Furthermore, discussed below, I inject a couple of additional screens that other researchers have not included, when measuring the return characteristics of a portfolio of Net-Nets.

Biotech companies

First, I exclude from the index all Biotech companies. Based on my own previous experience, small Biotech companies tend to burn through all cash that is provided to them, even when facing disappointments in clinical trials. As such, an investor should not expect a Biotech company trading below NCAV to be liquidated before all cash on the balance sheet has been consumed. My experience is quite the opposite, when the cash runs out, Biotech firms usually try to raise more money for further clinical trials.

Companies domiciled in China

In addition to Biotech firms, I also exclude all stocks which are domiciled in China. This being due to the several high-profile frauds that have been exposed in media involving Chinese firms listed on US public markets.

Examples include Luckin Coffee (NASDAQ:LK) and Wuhan Kingold Jewelry (NASDAQ:KGJI). Also, Netflix (NASDAQ:NFLX) even made a documentary called “The China Hustle” exposing small-cap Chinese stock frauds. Furthermore, future regulatory changes may require several Chinese-listed companies to de-list from US markets.

Of course, not all Chinese entities listed in the US involve fraud, however, for the purpose of building a Net-Nets index, I exclude them all.

Other screens

Finally, after removing biotech firms and Chinese companies, I finalize the construction of the index by reviewing all stocks left with regards to: (1) Is the company a serial issuer of common stock (risk of dilution)? (2) Is the company burning through the remaining cash on its balance sheet at a quick pace (will the estimated liquidation value disappear)? (3) Is the company operating in the financial industry (leverage is inherent in the business model for most financial companies)? (4) Is the company’s financial disclosures not provided in a timely manner (why would a company not provide its 10-Q on time)? (5) Is the company may be involved in some form of fraud?

If my review provides a Yes to any of these questions, I exclude the stock from the index. This screen is of-course the most subjective of the screens I use, but I feel it is important to ensure the overall quality of the index and avoid steeping on apparent landmines.

Source: Morningstar database, Author analysis.

Trading frequency

Now that I have constructed a list of stocks to include in the index, what should the trading frequency be?

The research paper mentioned earlier performed a portfolio rebalance once every year. I adopt a monthly approach, where at the end of each month the current portfolio is adjusted to reflect the model portfolio proposed by the screening process (equal-weighted). I choose to have a higher trading frequency since a lot of the companies are not stocks that I want to be invested in for the long term. Warren Buffett calls these type of stocks “cigar butts.”

Net-Nets index

Below is the result of my labor. The Net-Nets index (+36.2%) has handily beat both the S&P 500 index (+1.1%) and the Nasdaq index (+18.9%), since December 2019.

Source: Author analysis.

Drivers of this performance were stocks from all kinds of industries, one industry in particular worth mentioning was construction and homebuilding. The index exited positions in the green with regards to companies Tutor Perini (NYSE:TPC), KB Home (NYSE:KBH), Toll Brothers (NYSE:TOL), Green Brick Partners (NASDAQ:GRBK), Taylor Morrison Home Corp. (NYSE:TMHC), M/I Homes (NYSE:MHO), HMG/Courtland Properties (NYSEMKT:HMG) and Beazer Homes (NYSE:BZH).

Trading activity was at its peak during the depth of the stock market downturn during March and April, as shown below.

Source: Author analysis.

Current constituents

Deep value investors interested in what the index currently is holding can find these stocks below. Please note that the majority of these entities are small companies with a market cap below $100 million. In general, it is rare to find companies with a market cap above $100 million trading at below NCAV.

Source: Author analysis.


Although historical research and my own constructed index indicate Net-Nets’ out-performance versus the stock market as a whole, there are some valid reasons for this.

Small-cap stock and Micro-caps in particular, are less liquid than larger-cap stocks. Hence, it can take time to build a position in any given name in the above list and the stock can be of no interest to institutional buyers.

There is also a higher fraud risk and default risk with such small companies, that an investor will not find with the majority of companies included in e.g. the S&P 500.

Hence, any investor seeking exposure in this space should carry out proper due diligence.

Disclosure: I am/we are long AXR, FRD, ISIG, PFIN, RELL, SVT, SGMA, MSN, TATT, GIGM, SPRT, SSY, HWCC, RBCN, NWHM, NCSM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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