Net-Net Meaning

Key Takeaways

  • Net-net is a value investing concept introduced by Benjamin Graham, involving selecting stocks having market capitalization less than their net current asset value (NCAV). The NCAV is calculated by subtracting total liabilities from the current assets.Although such stocks are still present in the field, it is often hard to identify, and many use screeners.The impact of evolving business models and culture has reduced the effectiveness of this investing strategy.

How Does Net-Net Investing Work?

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Warren Buffet had also advocated net-net investing as it was a popular strategy back in the day. Graham advocated purchasing stocks by considering their net current assets, overlooking long-term assets. According to this concept, if the NCAV of a company is greater than its market capitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more, it becomes a net-net stock.

Essentially, NCAV is a value calculated by subtracting the total current assets of a firmCurrent Assets Of A FirmCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more, such as cash and cash equivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation.  Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. read more, adjusted inventory and receivables, etc., from total liability, including preferred stocks. The traders typically identify stocks as net-net when they trade below 2/3rd of the NCAV.

The strategy could seem helpful for investors with limited funds as the stocks are priced lower than their liquidation valueLiquidation ValueLiquidation value is the value of assets that remain if the company goes out of business and is no more a going concern. Liquidation value is calculated only for tangible assets such as real estate, machinery, equipment, investment etc.read more. However, many experts have suggested that acquiring a handful of such stocks is fruitful when the companies’ balance sheets are favorable. However, restricting the sales of such shares within 1-2 years is preferable to hedgeHedgeHedge refers to an investment strategy that protects traders against potential losses due to unforeseen price fluctuations in an assetread more against possible risks arising due to losses incurred by the firm.

Net-Net Formula

Net current asset value and net working capital (NNWC) are the two formulas often referred to in this investment strategy.

Net current asset value = Current assets – Total liabilities

Or

= Current assets – Total liabilities + Preferred Stock

It is important to take adjusted values of current assets by ignoring risky values for inventory and debtors’ receivables. Doing so will give a more conservative and realistic picture of the organization.

Net-net working capital = [Cash+ short term investments+75% of accounts receivables+50% of inventory] – total liabilities 

Additionally, traders also calculate the per-share value of NCAV and NNWC by dividing the respective values by the number of outstanding sharesOutstanding SharesOutstanding shares are the stocks available with the company’s shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner’s equity in the liability side of the company’s balance sheet.read more. So, the stock’s per-share price must be 2/3 of the NCAVPS.

Net-Net Examples

Let us understand this concept in detail with examples.

Example #1

ABC Inc. is a public company with total liabilities of $400 million, including preferred stock. The current assets equal $1,000 million. Calculate the company’s net current asset value.

Net Current Assets Value (NCAV) = Current assets- Total Liabilities

  • = $1000 – $400= $600

Example #2

For a specific year, ABC Inc.’s balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more revealed that the net current asset value per share is $9. So, should the investor buy the stock as part of the net-net investment approach?

NCAVPS = NCAV/Number of shares outstanding

NCAVPS = $9

Preferable purchase price = 2/3 x NCAVPS

= 2/3 x $9

= $6

Problems with Net-Net

At a press conference, Buffett once said that evolving business models and cultural changes have made this investing strategyInvesting StrategyInvestment strategies assist investors in determining where and how to invest based on their expected return, risk appetite, corpus amount, holding period, retirement age, industry of choice, and so on.read more less lucrative in the modern age. Moreover, there is difficulty finding net-net stocks in the current market due to the improvised management activities like takeoversTakeoversA takeover is a transaction where the bidder company acquires the target company with or without the management’s mutual agreement. Typically, a larger company expresses an interest to acquire a smaller company. Takeovers are frequent events in the current competitive business world disguised as friendly mergers.read more.

There are also some other factors contributing to the problems like;

  • Focusing mainly on the quantitative aspect to pick cheap stocksMisrepresenting financial reports can mislead investors.A lousy business remaining lousy throughout its lifespanLacking competitive advantagesCompetitive AdvantagesCompetitive advantage refers to an advantage availed by a company that has remained successful in outdoing its competitors belonging to the same industry by designing and implementing effective strategies that allow the same in offering quality goods or services, quoting reasonable prices to its customers, maximizing the wealth of its stakeholders and so on and as a result of which the company can make more profits, build a positive brand reputation, make more sales, maximize return on assets, etc.read moreLacking ability as a long term investmentLong Term InvestmentLong Term Investments are financial instruments such as stocks, bonds, cash, or real estate assets that a company intends to hold for more than 365 days in order to maximize profits and are reported on the asset side of the balance sheet under the heading non-current assets.read morePersistent requirements to collect a group of such company stocks as a method for them to workInability to yield significant figures like wonderful businesses or growth stocks.

Is it Still Relevant?

During Graham’s time, whenever businesses were liquidated, many companies preferred to ascribe the working capital to the shareholders’ value. Therefore, the net-net approach was more practical than it is now. Today, closing a business usually attracts numerous costs which extract the working capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It’s a measure of a company’s liquidity, efficiency, and financial health, and it’s calculated using a simple formula: “current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)“read more. However, it may still be viable if one is well-versed with the market and tries to make short-term gains. This is also a method of dispersing the risks that may arise when trading. On the other hand, finding such stocks is extremely difficult, especially when the market trend is bullish.

This has been a guide to Net-Net and its Meaning. Here we discuss the formula to calculate the net-net examples and problems and how it works. You may learn more about financing from the following articles –

Calculation of NCAV is as follows:Net current asset value (NCAV) = Current asset – Total liabilities + Preferred Stock

They are still available, but it’s hard to find them in the bullish scenario. In February 2021, TAT Technologies and Nova LifeStyle Inc were reported to appear as such a stock.

The term net-net refers to the companies trading at a very cheap value. As a result, their market capitalization will be less than the net current asset value.

  • Growth InvestingPassive InvestingEthical Investing