The value of a company’s net assets (or “NAV”) is the residual percentage in its assets when all of its liabilities have been discharged. In other words, NAV is the company’s capital and is seen as a buffer against which the company’s market capitalization should rarely fall below.
“NAV” or “Share capital / number of shares” = “NAV to share” and should serve as a rough guide, below which the share price of a good company should not be traded. Sometimes, however, stocks trade below that ratio for a number of reasons … not all of them are good. Sometimes the market takes into account future losses or the flow of losses that will be reflected in the assets of the business, so trading below this ratio is not always a sign of a deal.
However, when looking at NAV, company accounts often include assets such as software, goodwill and / or capitalized contracts that may not be worth the same monetary value for which they were purchased (so accounted for). Most of these assets fall into the category of “intangible assets” (as defined by IFRS) and are excluded from total assets when calculating the value of net tangible assets or the value of net tangible assets (“TNAV”).
TNAV per share is a very strict measure of the absolute lower level, which should be traded any share in a profitable business, because it believes that all intangible assets are worthless. In a sense, TNAV can be seen as the liquidation value of a business (except for the accounting constraints explained below).
NAV and TNAV are balance-based ratios and depend on balance reliability. In turn, the balance sheet is subject to the same limitations and inconsistencies that plague the accounting system that creates it.
Accounting inconsistencies are numerous and include the following main ones:
* Some assets are capitalized at historical cost and this is different from their resale / fair value and / or replacement cost. Which one is more important for NAV and TNAV …?
* Some assets are measured at fair value and others are not. So you are essentially using apples and bananas in the same proportions.
* Estimates are an integral risk for accounting. Accountants must estimate the useful lives of assets for depreciation, estimate the residual value for depreciation, evaluate guarantees and the profitability of reserves, etc. All of these estimates are susceptible to both manipulation and / or error, which adds to the unreliability of the final factor.
Thus, although NAV and TNAV are useful to watch, their limitations should be understood. In addition, although a business’s assets are important, its ability to generate profits is much more important from an investor’s perspective and should be emphasized before any liquidation costs.