Net-Net

Net-Net Meaning

Net-net refers to a company that is trading at a very low price with its market capitalization lower than its net current asset value (NCAV). Essentially, the technique is a conservative investing strategy focusing on acquiring stocks at a price lower than their liquidation value. In this process, the traders need to take into account the net current assets of the company.

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?

Net-Net

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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 taking into consideration 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-net working capital (NNWC) are the two formulas often referred to with 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 per-share price of the stock 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, inclusive of 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 net current asset value per share is $9. At what price 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, Buffet 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;

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.

Frequently Ask Questions (FAQs)

How is NCAV calculated?

Calculation of NCAV is as follow:

Net current asset value (NCAV) = Current asset – Total liabilities + Preferred Stock

Do net-net stocks still exist?

Yes, 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.

What does net-net mean?

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.

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