NAV is a useful number when valuing companies. It has some shortfalls though, so it’s worth understanding how it works, and when it doesn’t.
First, what is NAV? Starting with the balance sheet, you have assets (things you own, such as buildings, intellectual property and inventories) and liabilities (things you owe, primarily debt). These two aren’t equal and the difference is the NAV, assuming your assets are larger than your liabilities. If they’re not the company is technically bankrupt.
Taking NAV, you then divide by the number of shares and you get a NAV per share. You’ll notice most listed companies take above that value, the reason being that you’re not buying the company for the NAV — you’re buying future profits and cash flows, hence the premium.
But using NAV relative to share price can tell us lots, especially when looking at the trend over a period of many years. For example, Nedbank, Absa and Standard Bank were all trading at about one times NAV earlier in the year (the term used with banks is price-to-book, with book being the NAV). Historically this is a cheap valuation for them and we have seen the share prices all rise in recent months.
NAV is also useful in real estate investment trust (Reit) investing. Here it is used in two areas of valuation, with the NAV being the value of the buildings the company owns. Ideally you want to buy Reits that are trading at a discount to NAV. The top of the local Reit market, in 2017, was when the shares were trading well in excess of NAV.
The other use for NAV in a Reit is loan-to-value. This is expressed as a percentage as to how much the debt is relative to the value of the buildings owned. Ideally this is mid-30%, but that raises the question about how reliable NAV is.
Reits typically revalue buildings on a three-year rolling basis, using independent valuers.
But there is another issue with NAV and that is goodwill. If company A buys company B for R1m but the NAV of company B was only R800,000, there is a R200,000 goodwill value. This is what is paid above NAV, but it needs to go somewhere on the balance sheet of the acquiring business. So it gets added as an asset. The problem then occurs when the company being acquired does poorly; directors may elect to impair the goodwill, writing it down and essentially admitting that they overpaid, as we saw with the disastrous Woolies excursion into Australia.
I certainly use NAV in my valuation process, looking at the 10-year trend and comparing a company against its peers. But like any tool, it is used in conjunction with other ratios, and I certainly don’t add extra weight to the NAV valuation.
I am also cautious on too much goodwill on a balance sheet as this often gets written down, hurting earnings — but that’s another week’s story.