In finance, market participants have a range of tools that guide their decision-making amid all the complexity. Understanding these can help tackle the hesitance many faces while trading stocks. Among the typical toolkit for traders and investors, is the classical financial metric, the Net Asset Value (NAV).
It has been lauded by top investors in the market, given its ability to ensure stellar, profit-oriented trade strategies.
NAV is essentially a calculation-based metric that delivers tremendous insight to market participants, helping them to make informed decisions.
It gives investors information that sheds light on the potential intrinsic value of the financial security, based on which one may determine whether it is over or underpriced.
Like most financial metrics, the Net Asset Value has some compelling strengths, along with certain limitations. Insight derived from the NAV model is best when tied into a broader context of ratios and tools.
Looking at the wider picture, which can often get lost amid market technicalities, the NAV answers a fundamental question, which relates to the inherent worth of a company.
What Is Net Asset Value?
The Net Asset Value is a mainstream and classical financial metric that market participants, and especially retail traders and value investors, turn to, in order to calculate the valuation of a specific stock.
The outcome of this calculation is then compared with the trading market price of the security, which is then subsequently used to make a buy, hold, or sell decision.
The NAV is favored by so many in the market because of its ability to provide a snapshot of a particular stock, on the basis of its assets and debt, at a particular point in time.
This provides crucial information in real-time which allows traders to invest in bargain value opportunities, or to sell off stocks that hold inflated prices, from one’s portfolio.
Despite this straightforward nature which holds tremendous appeal in the market, it is important to point out that the NAV merely provides an estimate of a company or fund’s value, and the figure can fluctuate over time with shifts in asset fair values.
How to calculate Net Asset Value?
Calculating a stock’s net asset value is a straightforward arithmetic process in which one subtracts the total liabilities from the total assets shown on a company’s balance sheet, and divides the result by the number of outstanding shares.
This calculation gives its outcome on a per-share basis, which standardizes it for comparison against the stock price in the market.
Expressed mathematically as an equation, this would be as follows:
This seemingly straightforward calculation is carried out in the following manner:
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- Determine the total value of the assets of the company, including its fixed assets, cash holding, investments in stocks, bonds, and other financial securities.
- Find out the total value of the company’s liabilities, which includes short and long-term debt, along with other payables.
- Subtract total liabilities from the overall asset base.
- Divide the result by the total outstanding shares to get the figure on a per-share basis.
How to Interpret the Net Asset Value
There are two primary ways market participants typically interpret the NAV of a particular stock under study. The first approach is to compare the figure with the stock price, which helps determine how valuable it presently is.
If the stock price is lower than the NAV, it is trading at a potential discount, and if the stock price is higher, in that case, the stock is trading at a premium. This is a simple way for investors to make buy or sell decisions, based on relative valuation.
Additionally, the NAV can be interpreted on the basis of trend analysis.
When the NAV is known to consistently trade higher than the stock price, on a historical basis, there is an indication that it is highly demanded in the market, due to strong fundamentals.
Moreover, an increasing NAV trend over time also hints at improving financial performance, which translates to a strengthening balance sheet. This too is extremely insightful to market players, looking to pick their next winner.
Net Asset Value Example
Now that we have gone over NAV on a conceptual basis, it’s time to take things forward with a hands-on approach, looking at a real-life Net Asset Value example, to drive the point straight home.
For this scenario, we use the giant global, American retailer and wholesaler, Walmart Inc. (NYSE: WMT).
Looking into the company, we see that Walmart has total assets amounting to $244.9 billion, whereas its total liabilities are reported at $161.6 billion. The difference between the two works out to a surplus of $83.3 billion.
Considering that Walmart currently has 2.71 billion outstanding shares, its NAV is worked out as being $30.7 per share, according to its latest balance sheet figures.
The figure for this net asset value example is significantly below the company’s current share price, which is over $140.
Such a significant difference often arises when a company is backed by strong market sentiment, and also has promising future prospects, for which investors are willing to pay a significant premium.
Define Net Asset Value
A sound way to define net asset value is as follows:
“The net asset value of a stock is the value of its total assets minus the value of its total liabilities, divided by the overall shares outstanding.”
As is the case with any form of market terminology, it is crucial to correctly define net asset value.
Without a solid definition, it may be likely that different financial metrics are being labeled within a single terminology, causing a lack of transparency in the overall market.
Moreover, regulators may likely ensure companies report figures such as the NAV on a timely basis, which may require an applicable and well-accepted definition of the concept to be penned.
Net Asset Value Model
Because of its usefulness in presenting a sound snapshot of a company’s financial state, the NAV figure is often used as input to intricate financial models.
Being a valuable financial tool this allows for informed investment decisions, regarding a stock’s valuation.
For instance, hedge fund managers typically make use of complex net asset value models to keep track of stock prices within their portfolios in relation to the respective spot prices.
Once these levels fall to certain critical points (such as 50% of stock price, for instance), managers take timely decisions to sell off such holdings.
Similarly, market bears use net asset value models and similar tools to identify which stocks to short-sell amid failing financials.
Net Asset Value in Mutual Funds
With all the appeal that NAV holds, it is particularly favored by mutual fund managers and its shareholders, as a critical benchmark, based on which market performance can be tracked.
Whether a mutual fund’s price is trading at a discount or a premium is especially important, even more so than in the case of ordinary company shares.
This is because the fund derives its value purely and primarily from its holdings, so if its value of holdings shows a discrepancy from the market price, it is time for action.
For this reason, the NAV model is one of the primary tools used to provide information to shareholders and fund managers.
Net Asset Value in Closed-End and Open-End Funds
Open-end funds (OEF) and closed-end funds (CEF) are different investment vehicles that offer distinct advantages to market participants, of different investment approaches. Remarkably, the NAV concept plays a major role in each of these forms of funds.
For the CEF, NAV is used as benchmark criteria, based on which the prices are compared. Because the fund is closed-end, its price can fluctuate above and below the NAV figure, depending on the supply and demand for its shares.
On the other hand, for OEFs, NAV is used as an aide to guide investors as to which point is optimal for them to buy shares from or sell to the fund, directly.
For this purpose, the NAV would be calculated on a daily basis, with investors buying at discounts and selling at premiums. It is thus the go-to metric for anyone involved with open and closed-end funds.
NAV and Fund Performance
Given its usefulness in determining the value of a security in relation to its price, it is no surprise that the NAV is positioned as the go-to metric for appraising fund performance.
It gives a straightforward answer as to whether a stock is undervalued or overvalued.
But it is important to note that an isolated reliance on NAV can result in misleading conclusions, which is why it is usually used alongside other tools, in a holistic context.
The reason is that NAV is typically historically oriented, and does not account for future growth.
Despite this, however, it is hard to omit the NAV model from an analyst’s toolkit, as it portrays valuable insight.
Difference between NAV and Shareholder Equity?
We have already defined the net asset value and delved into its importance to value investors. Shareholder equity, alternatively, is a different financial metric that reveals the residual interest in a company.
It subtracts total liabilities from total assets and hence reports the part of the balance sheet that shareholders have a claim to. It does this by eliminating the factor of obligations.
Unlike NAV which focuses on the market performance of a security, shareholder equity usually revolves around the company’s ability to manage obligations in a sustainable manner.
Both shareholder equity and NAV are useful metrics that are used to determine the attractiveness of a particular stock. However, they each tap into distinct domains, which provide different information, that is each valuable to market participants.
Conclusion
In conclusion, NAV is a crucial financial tool that provides critical insight into particular stocks trading in the market.
Its ability to directly portray whether a stock is overpriced or underpriced based on what its balance sheet reports, makes it a favorite among many in the market, particularly those involved with mutual funds.
In the analyst’s quest to determine value, few metrics have proven their mettle, as well as NAV, has.
It is important to note, however, that the exclusive use of NAV, without complementary financial tools, could potentially portray an incomplete picture of the financial health of a stock.
However, even in the most holistic investigations into a particular stock, the NAV figure ranks quite high up for the information it provides.
FAQs
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Is a higher or lower Net Asset Value better?
A stock with a higher NAV is typically viewed as being superior to that with a lower NAV. It indicates that a company’s assets outweigh its liabilities by a larger margin, and thus is considered financially healthier against a stock that has a lower NAV.
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What happens if NAV increases?
An increase in the NAV of a stock is an indication that the company’s asset base has outgrown its liabilities. Such an occurrence is viewed favorably by market participants, as it indicates an improving financial position.
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Is it good to invest with a low NAV?
Investing in a stock with a low NAV is usually considered to be risky, and must generally be avoided, as it indicates that the company’s assets are not sufficiently covering its debt obligations.
This could pose risks for the business moving ahead, and may impact operations in an adverse manner. However, the NAV is just one of many aspects to stock, and a holistic assessment will always deliver the clearest picture. -
Can NAV be negative?
Yes, net asset value can and certainly does turn out to be negative for several companies. This happens when a company’s liabilities outweigh its assets, and so the net asset figure is negative.
This is usually considered to be a red flag in the market, as it points to poor financial management, and emphasizes the risk of bankruptcy.
