Net Asset Value and Tangible Net Asset Value

A company’s net asset value (or “NAV”) is the residual percentage of its assets after all of its liabilities have been deducted. In other words, NAV is the company’s equity and is seen as a buffer that the company’s market capitalization should rarely fall below.

“NAV” or “Equity / number of shares” = “NAV per Share” and should serve as a rough guide below which a good company’s share price should not trade. However, sometimes stocks trade below this ratio for a number of reasons…not all of them are good. Sometimes the market takes into account a future loss or stream of losses that will affect the company’s assets, so trading below this ratio is not always indicative of a bargain.

However, upon closer examination of NAV, a company’s books often contain assets such as software, goodwill and/or capitalized contracts that may not be worth the same monetary value for which they were purchased (and thus accounted for). The majority of these assets fall within the category of “intangible assets” (as defined by IFRS) and are excluded from total assets when calculating tangible net asset value or tangible net asset value (“TNAV”).

TNAV per share is a very strict measure of the absolute low that any stock of a profitable company should trade since it assumes all intangible assets are worthless. In a way, TNAV can be viewed as a company’s liquidation value (except for the accounting limitations discussed below).

NAV and TNAV are both balance sheet based metrics and depend on the reliability of the balance sheet. The balance sheet, in turn, is subject to the same limitations and inconsistencies that plague the accounting system that produces it.

The accounting inconsistencies are numerous and include the following important ones:

* Some assets are capitalized at cost and these differ from both their resale value/fair value and/or their replacement cost. What is more important for NAV and TNAV…?

* Some assets are measured at fair value, others are not. So you’re essentially using apples and bananas in the same ratio.

* Estimates are an inherent risk in accounting. Accountants must estimate the useful life of assets for depreciation, estimate the salvage value to be depreciated, estimate warranties and income for accruals, etc. All of these estimates are both manipulable and error-prone, increasing the unreliability of the final ratio.

So while NAV and TNAV are useful, their limitations should be understood. While a company’s net worth is important, its ability to generate profits is far more important from an investor’s perspective and should be emphasized above all liquidation assets.