What is Net-Net?
Net-net is a value investing technique developed by the economist Benjamin Graham, where a company’s stock is valued based solely on its net current assets per share (NCAVPS). Net-net investing centers on current assets—cash and cash equivalents at full value, accounts receivable adjusted for doubtful accounts, and inventories valued at liquidation prices. Net-net value is calculated by deducting total liabilities from these adjusted current assets.
This technique should not be confused with a double net lease, which is a commercial rental agreement where the tenant handles property taxes and insurance premiums.
Empowering Takeaways
- Benjamin Graham’s net-net strategy uses net current asset value per share (NCAVPS) to appraise stocks.
- Current assets’ efficacy in revenue generation is the crux of a business’s value according to net-net strategy.
- Includes cash and assets convertible to cash within 12 months, such as accounts receivable and inventory.
- Formulated mainly for short-term gains, long-term investments might find the strategy lacking according to some critics.
Unlocking the Essence of Net-Net Investing
Graham advocated this approach when financial data wasn’t as accessible, making net-nets a widely accepted valuation model. Modern financial analysis tools now enable comprehensive evaluations, but the net-net strategy remains relevant for identifying undervalued stocks based on current assets over liabilities.
Investing in a net-net offers apparent short-term safety as its current assets overshadow its market price, offering long-term asset value potentially for free to an investor. Net-net stocks typically align closer to their true value in the short run, though long-term prospects can be risky.
The formula for NCAVPS (Net Current Asset Value Per Share) is:
NCAVPS = (Current Assets - Total Liabilities - Preferred Stock) ÷ # of Shares Outstanding
Graham suggested investing in stocks priced at no more than 67% of their NCAV per share, a theory supported by a study showing an average return of 29.4% from 1970 to 1983 for such investments held for a year. However, investors are urged to diversify, ideally holding at least 30 stocks.
Special Considerations for the Savvy Investor
Current assets, vital in the net-net approach, include cash and assets converted to cash within 12 months, factoring in accounts receivable and inventory. The ability to swiftly convert these to cash highlights a firm’s true value according to net-net principles. By subtracting current liabilities, net current assets focus solely on cash-generating potential within the next year.
Critiquing Net-Net
Net-net stocks may falter as long-term investments because management may not opt for immediate liquidation at adversity’s onset. Short-term rectification between current assets and market cap could occur, but poor management or flawed business models may quickly destabilize the viability of such stocks. Instances where an otherwise undervalued stock enters a net-net position, it’s often due to previously identified long-term challenges. A notable example includes retailers adversely impacted by e-commerce giants like Amazon, which short-term can present successful investments but long-term, they often falter or get acquired at lower valuations.
Net-net strategy’s focus on market value below net-net working capital (NNWC) involves strategies like quick evaluations by day traders, boosting short-term stock valuations but may not guarantee long-term stability.
Related Terms: Value Investing, Net Current Asset Value, Stock Valuation, Current Assets, Financial Ratios.
References
- CFI. “Net Current Asset Value Per Share (NCAVPS)”.
- Oppenheimer, H. R. (1986). “Ben Graham’s Net Current Asset Values: A Performance Update”. Financial Analysts Journal , 42(6), Pages 40-47.
- American Association of Individual Investors. “Benjamin Graham’s Net Current Asset Value Approach”. Email required.
