Net asset value broken down

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Net asset value (NAV) is a term often used when valuing investment trusts, including many property companies and certain other companies whose balance sheets are full of valuable assets or investments.

NAV is regularly quoted for mainstream investment trusts and property companies such as real estate investment trusts (Reits).

It is calculated by taking the difference between total assets and total liabilities, a figure termed shareholders' equity. The result is divided by the number of issued shares to arrive at a per share value. This is then compared with the share price.

Often the shares of asset-rich companies sell at a substantial discount to their true underlying value, as expressed by NAV. In theory, the bigger the discount, the greater the undervaluation. However, the theory breaks down because the absolute level of any discount to NAV doesn't tell you enough.

A company's shares may sell at a big discount to NAV if the assets have not grown in value much in recent years. Indeed, if they fall in value, or are expected to, the discount to NAV on which the shares sell could widen further, hitting the share price. This is precisely what has happened with UK property shares over the last few years, although they have subsequently recovered to some extent.

There are also plenty of cases of companies selling at hefty discounts to NAV on a semi-permanent basis if there is no prospect of action being taken to change matters. In other words, a catalyst (such as a bid or a change of management) is usually needed.