What Is Net-Net?

What Is Net-Net?

Let me explain what net-net investing is all about. It's a strategy from Benjamin Graham that looks at a company's stock through the lens of net current assets per share, or NCAVPS, to spot undervalued opportunities. You focus on cash and equivalents, make deductions for accounts and inventories, and completely ignore long-term assets. This way, you're zeroing in on immediate liquidation values. If you're hunting for undervalued stocks, understanding this method can help you identify real prospects.

Key Takeaways

Here's what you need to know right away. Net-net is a value investing approach from Benjamin Graham that zeros in on net current assets, leaving out long-term assets and liabilities. You look for stocks trading below 67% of their net current asset value per share—these could be undervalued. Critics point out it's not great for long-term holds because it misses deeper issues that might hurt future performance. This strategy was bigger back when financial info was scarce, but now with better data, you can do more thorough analyses.

How Net-Net Investing Works

Graham developed this during times when financial data wasn't easy to get, and net-nets were a standard way to value companies. When you spot a viable net-net, you only analyze current assets and liabilities—forget other tangible assets or long-term debts. Today, with advances in data, you can pull up full financial statements, ratios, and benchmarks quickly.

Investing in a net-net felt safe for the short term because current assets beat the market price. Essentially, you get long-term growth potential and asset value for free. The market usually catches up and reprices these stocks closer to true value soon after. But long-term, they can be tricky.

The NCAVPS formula is straightforward: NCAVPS = Current Assets - (Total Liabilities + Preferred Stock) ÷ # Shares Outstanding. Graham said to buy when the stock price is 67% or less of NCAV per share for big upsides. A study from the State University of New York found that from 1970 to 1983, this could net you an average 29.4% return by holding for a year.

Not every stock picked this way wins, so diversify. Graham suggested at least 30 stocks in your portfolio.

Important Factors in Net-Net Investing

Current assets in this approach are cash or things turning into cash within 12 months, like receivables and inventory. As a business sells stock and collects payments, it cuts down on inventory and receivables—that's the real value here, according to net-net.

You subtract current liabilities, like payables, to get net current assets. Long-term stuff is out of the picture; it's all about cash generation in the next year.

Limitations and Criticisms of Net-Net Investing

Net-net stocks might not hold up long-term because management doesn't always liquidate at the first sign of trouble. Short-term, they can close the gap between assets and market cap, but bad management or a weak model can wreck the balance sheet fast.

These stocks often end up as net-nets because the market sees long-term problems. Take how Amazon pushed retailers into net-net territory—some investors made short-term profits, but many of those companies failed or got bought cheap later.

Using net-net working capital—cash plus short-term investments + 75% receivables + 50% inventory minus total liabilities—can work for small investors. Day traders hunt these, which might pump up their value month to month.

The Bottom Line

Net-net investing, started by Benjamin Graham, evaluates companies via NCAVPS for short-term safety in stocks below 67% of NCAV—studies show it can deliver strong returns. But skipping long-term assets and liabilities brings risks for long-haul investors. These stocks might be cheap due to real flaws, so do your research and diversify to use this strategy right.