Liquidation Value: Why It Might Be the Best Valuation Technique

It's amazing that so few investors focus on liquidation value when the approach performs so well. Instead, many focus on long term growth rather than net net stocks - an approach even Charlie Munger called "a free lunch."

But what exactly is liquidation value? Is it limited to Ben Graham's net nets, or can you apply liquidation analysis in other ways?

This is exactly what I want to talk to you about today. By the end of this article, you should have a clear understanding of what liquidation value is, how to use a liquidation value formula to assess liquidation value, and the returns on offer from various liquidation value strategies. Let's get going...

The Liquidation Value Formula

Every good measure in finance comes packaged in a formula. Liquidation value is no different. But, liquidation value can be measured in different ways. Let's step back to the very basics to help explain which liquidation value formula may be best in different situations.

What Is Liquidation Value?

Liquidation value in investing is the value that would be left over to distribute to shareholders if a firm were to close its business, sell off its assets one by one, then cover its financial obligations prior to the common stock.

Is Liquidation Value the Same As Liquidation Value of Assets?

Liquidation value of assets is just another way to refer to liquidation value - the value shareholders would receive after their company closed its doors, sold off its assets, and paid its debts. Adding the "of assets" to the term is redundant - what else would you liquidate?

Net Liquidation Value vs Book Value: A Critical Difference

Is liquidation value (or, some call it "net liquidation value") the same as book value?

No. Liquidation value is an estimate of the value that would be obtained if you were to liquidate the company, selling off all assets, paying off liabilities, and distributing the remainder to shareholders. Book value attempts to represent the value of the assets and liabilities that comprise the business. The assets recorded may or may not have value in liquidation, and their values may or may not reflect their resale value.

The problem is mostly in the long term asset accounts. These assets have depreciation schedules that may reduce their values on the books at faster or slower rates than actually seen in the real world. So, the value of a long term asset can be significantly different than its real world value if the company were to sell the asset.

Add to that intangibles and goodwill which may be carried at significant values on the balance sheet but may or may not have any value in the real world... and you get a section on the balance sheet that is highly problematic when assessing a firm's liquidation value.

Current (or "short term") asset values on the balance sheet still vary relative to their real world values, the the degree of difference is much smaller than with fixed assets.

What is the Formula for Liquidation Value?

There are multiple formulas that an investor could use for calculating liquidation value. Some have more relevance than others, and the best approach is to use the best formula possible for each specific scenario. These formulas include: net current asset value (NCAV), net net working capital (NNWC), and net asset value (NAV).

Note that net tangible asset value (NTAV) and book value ("book") are slightly removed from a true liquidation value assessment because, as I wrote above, they do not discount balance sheet accounts to arrive at a more precise valuation.

By contrast, the first group make adjustments to a company's long term (or "fixed") asset balances, or remove entire account sections to arrive at a more accurate figure.

Net Current Asset Value (NCAV) Formula

The liquidation value formula using NCAV is:

NCAV = current assets - (total liabilities + preferred shares + off balance sheet liabilities)

This formula takes into account only current assets. The idea is that during a forced liquidation, valuations may prove overly optimistic on the balance sheet for fixed asset items. By excluding them, but including the full value of the firm's current assets, any shortfall in those current assets would be made up for by any value actually obtained by the fixed assets during liquidation.

NCAV is not the most accurate measure of liquidation value, but it is one of the two the most conservative. No other formula outrightly excludes fixed assets from its calculation. Another benefit of using this formula is that you're unlikely to overpay for a firm if you're basing its value on liquidation value. NCAV has also been used in many studies that looked at Graham's "net nets" as an investment strategy.

This formula is best used for firms that have a good portion of their assets in the current asset account, and a smaller proportion as fixed or long term assets. But, if a firm does not have much or any fixed assets, it would be more conservative to use the next formula.

Net Net Working Capital (NNWC) Formula

The liquidation value formula using NNWC is:

NNWC = [Cash + (Receivables x 0.8) + (Inventory x 0.67) + (Other Current Assets x 0.25) + (Tangible Fixed Assets x 0.15)] - [Total Liabilities + Preferred Shares + Off Balance Sheet Liabilities]

The NNWC liquidation value formula was introduced in Benjamin Graham's Security Analysis series, and is the second of the most conservative assessments of liquidation value. The formula applies a discount to all accounts, but excludes intangible assets.

As famous value investor Seth Klarman explains:

“In approximating the liquidation value of a company, some value investors, emulating Benjamin Graham, calculate ‘net-net working capital’ as a shortcut. Net working capital consists of current assets (cash, marketable securities, receivables, and inventories) less current liabilities (accounts, notes, and taxes payable within one year.) Net-net working capital is defined as net working capital minus all long-term liabilities. Even when a company has little ongoing business value, investors who buy at a price below net-net working capital are protected by the approximate liquidation value of current assets alone. As long as working capital is not overstated and operations are not rapidly consuming cash, a company could liquidate its assets, extinguish all its liabilities, and still distribute proceeds in excess of the market price to investors.”

The benefits of using this approach over NCAV is that it includes some value from the firm's fixed assets, and does not take the full value of the firm's current assets. As such, it is better for calculating a highly conservative liquidation value for firms that have a greater portion of long term assets to fixed assets. Its major disadvantage is that it is not as simple to use as NCAV.

Net Asset Value (NAV) Liquidation Value Formula

The NAV liquidation value formula is:

NAV = Market Value of All Assets - (Total Liabilities + Preferred Shares + Off Balance Sheet Liabilities)

The NAV liquidation value formula is more accurate than either of the first two liquidation value formulas, but requires significant industry knowledge to calculate. An investor using the approach would have to assess how much of the receivables are collectable, how much the company could actually fetch for its inventories, and what the true sale values would be for the firm's fixed assets. This requires significant research and knowledge of the assets owned.

This approach is best suited for industries where there are active markets for the company's major assets, such as real estate or cargo ships. In these situations, an investor can make a much closer assessment of the true value that the assets would fetch in liquidation, so can come up with a much more accurate liquidation value.

Note that this approach includes intangible assets, such as brands, intellectual property, patents, etc. All of these intangible assets may have significant value (or no value whatsoever) in liquidation. Where as a company could easily sell a vehicle in liquidation, there may be readily available buyers for assets such as pharmaceutical patents.

A Hybrid Approach to Liquidation Value Formulas

Liquidation value investors rarely stick 100% to any one liquidation value formula, and may alter the formula to fit the situation at hand. I typically use a blended approach when assessing the liquidation values of non-typical cigar butts - firms that don't conform to the common NCAV formula.

I would use, for example, NAV for the shipping industry, but take the current assets at face value while applying a market value for the ships based on recent similar transactions. I could discount the current accounts, but the value of the discount is more of a rounding area here since most of the value of the business is comprised of the company's ships.

Other investors are steadfast in their belief that intangible assets should not be a part of the liquidation value calculation. In his book Margin of Safety, Seth Klarman defines liquidation value this way:

“The liquidation value of a business is a conservative assessment of its worth in which only tangible assets are considered and intangibles, such as going-concern value, are not. Accordingly, when a stock is selling at a discount to liquidation value per share, a near rock-bottom appraisal, it is frequently an attractive investment.

The assets of a company are typically worth more as part of a going concern than in liquidation, so liquidation value is generally a worst-case assessment.”

Klarman considers liquidation value to be essentially a worst-case assessment of a company’s intrinsic value - a fire sale of its assets.

So, what is the formula for liquidation value? There are many and the best formula depends on the situation at hand.

How Do You Calculate Forced Liquidation Value?

Forced liquidation value is best calculated using either the NCAV or NNWC formulas described above. This scenario is basically Klarman's fire sale scenario, where the assets have to be sold off in a hurry due to some legal requirement the company may have to satisfy or some external event to the company.

Forced liquidation value calculations are rarely required, though, since fire sales do not occur that frequently. In the case of net net stocks, for example, when a company decides to close its doors and sell everything off, most liquidations are orderly and management try to obtain maximum value for shareholders.

How Do You Calculate Net Orderly Liquidation Value

The best way to calculate net orderly liquidation value is to use NAV, since it provides the most accurate liquidation value assessment available. Assuming you do not know the exact values of the assets that the company could obtain through liquidation value, it would probably be best to use NCAV or NNWC.

In these scenarios, I would also try to assess the value of the fixed assets as best I could, while always staying conservative, and then applying that value in place of Graham's 15% figure. So, my preferred approach here would be to use NCAV and then add in some judiciously arrived at conservative value for the fixed assets.

How Do You Calculate Liquidation Value Per Share?

You calculation liquidation value per share by dividing the liquidation value you arrived at by the company's fully diluted share count.

It seems like a simple thing to do - find the per share liquidation value - but there are a number of ways to go off course here. many investors use outstanding share to calculation the per share value, but this only tells part of the story, since there are other securities that may be convertible into common shares, growing that shares outstanding figure after conversion.

You liquidation value per share formula needs to take into account all of the conversion that could happen below the liquidation value per outstanding share. The way I do this is to put the liquidation value on a per outstanding share basis, and then see if there are securities such as stock options that would be in the money below that value. If there are, I add those to the per share figure.

For example, if there are stock options with a $1.20 strike price, and the liquidation value per outstanding share comes in at $1.50, then I would add those shares to the shares outstanding figure to get my total shares figure.

No, it's not perfect, since adding those shares lowers the liquidation value per share, making conversion less valuable for those option holders, and you could do more adjustments as you see fit, but the ultimate differences end up being tiny in most cases.

Liquidation Value vs Market Value: What's the Difference?

The liquidation value of a company is the residual value left after selling off the assets, and then paying off all of the company's debts and other obligations. Market value, by contrast, is how much the company would be worth as a going concern.

Market value implies multiples, such as a multiple of sales, multiple of earnings, or multiple of cash flow. Sometimes investors use private market value, or the value that the business could fetch in the private market when sold to a knowledgable buyer.

When deciding between a liquidation value vs a market value approach, its best to consider how viable the company is going forward and whether or not it has significant sales, profits, or cash flow to base a market valuation on. If it's a troubled company (just my type!) then you will probably want to look at liquidation value rather than market value.

Can I just Use A Liquidation Value Calculator?

If you're asking this, you're kind of missing the point of the article. Security analysis does not lend itself to calculators and simple one click solutions. It is up to you as an investor to use your judgement in each scenario to figure out which liquidation value is best to use, and then which items to include and exclude.

Even if you're simply going to stick to a mechanical net net stock approach, you need to exercise significant judgement in how those calculations are carried out. There are tools that will assess the firm's NCAV for you, for example, but these tools use standardized financial statements which often omit items, blend items, or use the wrong set of statements altogether. These errors are much more frequent as you move to smaller and smaller companies.

So, Can you just use a liquidation value calculator? In my opinion, not if you want to do well with investing.

Liquidation Value Formula PDF

It can be tough to keep track of all of this if you are new to cigar butt investing or buying sub-liquidation value firms. That's why we created this liquidation value formula PDF download. We've packaged up all of the formulas and key examples so that you can refer to it easily when doing valuation work. Click the button here to get your free liquidation value formula PDF:

Liquidation Value Example Using A Real Balance Sheet

We'll be running through an example for each one of our liquidation value formulas listed above: NCAV, NNWC, and NAV. To do so, we'll be using McCoy Global's 2023 Q3 balance sheet:

Account	Value (’000)
Current Assets
Cash and Equiv	$14,006
Receivables	$9,400
Inventories	$29,060
Total	$54,271
Long Term Assets
Deferred Tax Asset	$1,212
Property, Plant, and Equip	$8,470
Intangibles	$5,897
Goodwill	$3,697
Total	$19,276
Total Assets	$73,547
Current Liabilities
Trade Payables	$10,755
Income Tax Payable	$1,324
Customer Deposits	$3,326
Current Provisions	$444
Current Lease Liabilities	$1,146
Dividends Payable	$269
Total	$17,264
Long Term Liabilities
Lease Liabilities	$3,547
Total	$3,547
Total Liabilities	$20,811
Equity	$52,736
Diluted Share Count	26,954,936

NCAV: What is an Example of Liquidation?

Putting together an example of liquidation using the NCAV formula is pretty straightforward. Remember the NCAV formula:

NCAV = current assets - (total liabilities + preferred shares + off balance sheet liabilities)

With NCAV, there's no need to assess long term assets, so assessing the valuation is simple and easy. McCoy doesn't have preferred shares, either, so it's a simple calculation to make.

NCAV = $54,271,000 - ($20,811,000 + 0 + 0)

NCAV = $33,460,000

Now, we'll put that liquidation value estimate on a per share basis, so we can compare the value to the stock price.

NCAV Per Share = NCAV / Diluted Share Count

NCAV Per Share = $33,460,000 / 26,954,936

NCAV Per Share = $1.24

McCoy has $1.24 in liquidation value, according to the NCAV formula. With a current share price of $1.65, the company trades a bit above NCAV so we wouldn't call it cheap relative to liquidation value. So, when we discount the current accounts, there isn't much in the way of long term asses value to make up the difference.

NNWC Liquidation Value Example

NNWC is a little more involved to calculate than NCAV. The formula is:

NNWC = [Cash + (Receivables x 0.8) + (Inventory x 0.67) + (Other Current Assets x 0.25) + (Tangible Fixed Assets x 0.15)] - [Total Liabilities + Preferred Shares + Off Balance Sheet Liabilities]

In McCoy's case, the values work out to:

NNWC = [$14,006,000 + $7,520,000 + $19,470,200 + $1,270,500] - $20,811,000

...and NNWC totals...

NNWC = $21,455,700

Again, to put this on a per share basis, just divide by the number of fully diluted shares.

NNWC Per Share = NNWC / Diluted Share Count

NNWC Per Share = $21,455,700 / 26,954,936

NNWC Per Share = $0.80

NNWC value comes out significantly lower than our NCAV valuation, since the company has significant current assets with a comparatively small number of fixed assets.

NAV Liquidation Value Example

NAV is a little more involved, requiring estimates of asset values according to readily available values in active markets. This is best used in the areas of real estate, or shipping, but we'll run through an example with McCoy and discuss our thinking below. You may agree or disagree with what we do, which is fine, but it will prove valuable to see how we think about specific accounts.

Account	BS Value (’000)	Rate*	Liquidation Value Est	Reasoning
Current Assets
Cash and Equiv	$14,006	100%	$14,006	The most accurate BS account
Receivables	$9,400	100%	$9,400	Allowance for doubtful accounts already present
Inventories	$29,060	90%	$26,154	Oil exploration bull market and they previously wrote down inventory
Total	$54,271		$49,560
Long Term Assets
Deferred Tax Asset	$1,212	0%	$0	An accounting entry with no resale value
PP&E	$8,470	15%	$1,271	Unknown value. Firm does not lay out PP&E assets in detail so applying 15% residual
Intangibles	$5,897	15%	$885	Related to new product platform development which would have some resale value but can't be determined so applying 15% residual
Goodwill	$3,697	0%	$0	Related to the purchase of businesses which have been absorbed into other parts of the BS
Total	$19,276		$2,156
Total Assets		100%	$51,716
Total Liabilities	$20,811	100%	$20,811	All liabilities assumed at 100%

With these values now in place, we can calculate a rough NAV for the company.

NAV = Market Value of All Assets - (Total Liabilities + Preferred Shares + Off Balance Sheet Liabilities)

NAV = $51,716,000 - $20,811,000

NAV = $30,905,000

NAV Per Share = $30,905,000 / 26,954,936

NAV Per Share = $1.15

Our NAV valuation produces a figure closer to our initial NCAV valuation. We consider this the most accurate, but not the most conservative.

How Can You Apply the Liquidation Value Technique to Your Portfolio?

Buying stocks below their liquidation values is the most profitable approach to classic Ben Graham value investing. Returns from other approaches don't come close to the CAGR you can achieve through Graham's net net approach.

What sort of returns are available?

Tweedy, Browne provided a breakdown of the returns available in their famous investment guide, What Has Worked In Investing. According to the legendary value firm, these classic value strategies achieved the following returns:

Strategy	1 Year Return	3 Year Return
Low PE	16.2%	63%
Low PCF	18.3%	69.5%
High Div Yield	18.5%	59.3%
Ultra Low PB	32.8%	113.7%
Net-Nets	34.5%	98.8%

You can download their full investment guide here:

The catch with any of these strategies is that you have to actually stick to them, and it can take a lot of work to identify suitable candidate for investment.

With net nets specifically, you need to sift through a lot of junk (incorrect balance sheet totals due to errors in standardized data found in screeners, very high asset erosion rates, unbuyable firms due to lack of volume, those with market caps associated with lower returns, industries or business types unsuitable for a proper NCAV or NNWC valuation, etc). With over 1000 net nets available globally at the time of writing, it takes our in-house analyst over 30 hours per month to filter through our net net screen to identify approximately 40 or 50 that are worth further research.

If you are doing it yourself, you can bet on spending much more than 30 hours to sort through all available net nets, or to miss out on some of the best finds if you cut corners and only filter through net net lists for a few countries. That's why it's important to get help. We find that without help, small investors eventually abandon these strategies, missing out on the exceptional returns on offer. This means a much smaller nest-egg for retirement, and a lower standard of living.

Each month, we help Net Net Hunter members implement the strategy by doing much of the initial leg work for them. First, we filter out all of the junk and net nets associated with lower returns from our raw screen to provide members with a condensed pool of research candidates in the form of our Net Net Hunter Shortlist. We've also crafted a high return mechanical net net approach that leverages our Shortlist, and publish analyses on net nets that meet our strict selection criteria. We also have dozens of high quality net net investors sharing their net net picks and providing feedback on specific issues each week. And, at the end of the year, we package up our member's best picks into a community portfolio and track it over the next 12 months.

In short, Net Net Hunter radically reduces the time and effort it takes to put together a high quality net net stock portfolio. If you're working full time, raising a family, or going to university so can't afford to spend 30 hours a month filtering through stock lists and researching promising buy candidates, you definitely need to explore Net Net Hunter membership.

Sub-liquidation value investing is some of the most profitable available in the market for small investors. At the end of his life, even Ben Graham revealed that he has renounced all other strategies and focused on net nets exclusively. So, it should come as no surprise that we recommend it for your own investing, too.

Article image (Creative Commons) by Frédéric BISSON, edited by Net Net Hunter.