Key Takeaways
- Buy stocks below net current asset value per share.
- Focus on liquid assets, ignoring fixed assets or growth.
- Targets deeply undervalued small-cap stocks with margin of safety.
What is Net-Net?
Net-Net is a value investing strategy developed by Benjamin Graham that focuses on buying stocks trading below their net current asset value per share (NCAVPS), essentially at a discount to the company's liquidation value. This approach ignores earnings and growth prospects, prioritizing a margin of safety by valuing only liquidatable current assets after subtracting liabilities.
The concept targets deeply undervalued companies often overlooked by institutional investors, making it a niche within factor investing.
Key Characteristics
Net-Net stocks have distinct features that help investors identify deep value opportunities:
- Market Cap vs NCAVPS: Stocks trade below two-thirds of their net current asset value per share, ensuring a significant discount.
- Focus on Liquid Assets: Only cash, receivables, and inventory are considered, while fixed assets and earnings are excluded.
- Margin of Safety: The strategy assumes liquidation value as a floor, reducing downside risk.
- Small-Cap Bias: Typically targets small-cap stocks with limited analyst coverage, similar to those found in best small-cap stocks lists.
- Contrarian Nature: Often applied to companies facing negative sentiment or temporary distress.
How It Works
Net-Net investing involves screening stocks where the market price is less than the NCAVPS, calculated as (Current Assets - Total Liabilities) divided by shares outstanding. More conservative adjustments discount receivables and inventory to reflect liquidation realities.
Investors typically build diversified portfolios of 30-35 net-net stocks, holding positions for about one year to capture value realization while minimizing trading costs. This approach can outperform traditional benchmarks by exploiting inefficiencies in macroeconomic cycles and market sentiment swings.
Examples and Use Cases
Net-Net investing suits value-focused investors looking for undervalued opportunities in overlooked sectors. Examples include:
- Airlines: Companies like Delta and American Airlines have occasionally traded near net-net valuations during industry downturns.
- Small-Cap Value Stocks: Many picks from best value stocks lists align with net-net criteria due to their attractive liquidation values.
- Volatile Earnings Firms: Firms with inconsistent earnings but solid current assets may be net-net candidates.
Important Considerations
While net-net investing offers a margin of safety, it requires careful analysis and patience due to potential volatility and prolonged undervaluation. Investors should consider diversification and stay mindful of hidden liabilities or off-balance-sheet risks that can affect true liquidation value.
This strategy may not suit all market conditions and should be complemented with broader portfolio approaches, including low-cost index funds for balance, such as those found in the best low-cost index funds category.
Final Words
Net-net investing focuses on buying stocks priced below their net current asset value, providing a strong margin of safety by valuing companies as if in liquidation. To apply this strategy, start by screening for stocks trading under two-thirds of their NCAV to identify potential deep value opportunities.
Frequently Asked Questions
Net-Net investing is a value strategy developed by Benjamin Graham that involves buying stocks trading below their net current asset value per share. It focuses on companies valued less than the liquidation value of their current assets after subtracting liabilities, prioritizing a margin of safety.
NCAVPS is calculated by subtracting total liabilities from current assets and then dividing by the number of shares outstanding. This metric helps identify stocks trading below their liquidation value, which qualifies them as net-net candidates.
Net-Net investing assumes a worst-case scenario, like liquidation, so it values only liquidatable current assets such as cash, receivables, and inventory. Fixed assets, earnings, or growth prospects are ignored because they may not hold value if the company goes bankrupt.
A stock is considered a Net-Net candidate if its market price per share is less than two-thirds of its adjusted Net Current Asset Value Per Share. This indicates the stock is trading at a significant discount to its liquidation value, offering a strong margin of safety.
Net-Net investing is often applied to deeply undervalued small-cap stocks, usually under $100-200 million market cap, that are overlooked by institutional investors due to their size or perceived risk. These stocks often have poor market sentiment and little analyst coverage.
NNWC adjusts net current assets for liquidation realities by valuing cash at 100%, accounts receivable at 75-80%, inventory at 50%, and subtracting all liabilities including off-balance-sheet items. This conservative approach provides a more realistic estimate of a company's liquidation value.
Investors typically screen for stocks with market caps above $100 million, positive NCAVPS, and prices below two-thirds of NCAVPS. They build diversified portfolios of 30-35 equally weighted stocks, often ranking candidates by their discount to NCAV to optimize safety and returns.
