Net asset value per share shows the book value of the assets attributable to each share
NAV per share = (Total assets - total liabilities - preference capital)/ number of ordinary shares Liabilities would include loan capital taken at current market value.
Limitations:
- (For companies other than investment trusts) Assets have value for their earning power which may not be related to balance sheet value. A company should be able to add value by combining assets with other factors of production in a business.
- With regard to investment trusts, management expenses will take money from the dividend stream accruing to the trust: if the management are not able to compensate for this by better performance than the market, this factor will act to produce a discount.
- Also, investment trust shares may be more volatile and less marketable than the underlying assets.
- There will be uncertainty as to the true net asset value of the trust. The idea that, if a discount existed, the trust could be taken over and liquidated is not realistic in practice: this will allow a discount/premium to exist. The marketability will also affect the discount to net asset value.
- Whereas the shares of a large trust will be more marketable than many of the underlying assets, the shares of a small trust may be less marketable.
- In practice the existence of gearing may also influence discount to net asset value per share. Trusts borrow to invest in equities thereby causing the price of their equity to fluctuate more than the underlying asset value.
- In theory, an investor should be able to reduce the equity proportion of his investment portfolio to remove the effect of gearing, however. A personal investor may be willing to pay an amount greater than net asset value per share for investment trust shares because of the portfolio diversification it provides at little cost.
Suitability
This use of this method depends on the balance sheet value of the assets being realistic (because the ratio in (iii) (a) is the balance sheet value of the assets per share). It is the earning power of the assets which is important for an ongoing concern however. For companies which hold reasonably marketable assets which can be valued, such as a property company, net asset value is a reasonable indicator of the value of the company. However, if a company is not easily able to value its assets or they are valued at depreciated historical cost, then the value of the earning power of the assets may deviate significantly from the balance sheet value. Valuation methods based on balance sheet values would therefore not be appropriate.