Net-net investing is a classic value strategy popularized by Benjamin Graham in the 1930s. It focuses on finding companies that are trading for less than their liquidation value, effectively allowing an investor to “buy a dollar for 50 cents.”
The Concept of Net-Net Stocks
A net-net stock is a company whose market capitalization is lower than its Net Current Asset Value (NCAV).
This means the market is valuing the business at less than the value of its liquid assets (cash, receivables, and inventory) after all debts and liabilities have been paid.
In Graham’s view, this provided a massive margin of safety. Even if the business itself was struggling, the assets alone were worth more than the price you paid for the shares.
How to Calculate NCAV?
To identify a net-net, you look strictly at the current assets on the balance sheet and ignore long-term assets like buildings, machinery, or patents, as these are harder to sell quickly in a liquidation.
Net Current Asset Value (NCAV) = Current Assets – Total Liabilities (Current + Long-term) – Preferred Stock
Graham’s Rule of Thumb: Graham typically looked for stocks trading at no more than two-thirds (66%) of their NCAV.
Example:
Current Assets: $100 million
Total Liabilities: $60 million
NCAV: $40 million
Buy Target: Market cap below $26.6 million ($40M x 0.66)
Global Business Examples
While net-nets were abundant during the Great Depression, they are rarer today and often found in small-cap or micro-cap sectors.
Japanese Micro-caps: In the last decade, Japan has been a prime hunting ground for net-net investors. Many small manufacturing firms (such as Shin-Nippon Air Technologies or various “Net-Net” baskets tracked by value funds) have historically traded below their cash and receivables value due to conservative management and lack of institutional interest.
Sector Downturns: During the 2008 financial crisis, several retail and manufacturing companies in the US and Europe briefly traded at net-net levels. For instance, Fossil Group and various small biotech firms (which often hold more cash than their market cap while burning through it) have frequently appeared on net-net screens.
The “Net-Net” Giant (Historical): Even Berkshire Hathaway was originally a net-net play. When Warren Buffett first started buying the textile mill, it was a struggling business trading well below its working capital.
Risks and “Value Traps”
Buying a company for less than its cash value sounds like a guaranteed win, but it comes with significant risks:
- Cash Burn: A company might have $50 million in cash today, but if it is losing $10 million a year, that “margin of safety” disappears quickly.
- Deteriorating Assets: Inventory may be obsolete (e.g., last year’s fashion or electronics), and accounts receivable may not be fully collectible.
- Management Misalignment: Some companies trade below liquidation value because management has no intention of liquidating or returning cash to shareholders, choosing instead to “waste” it on failing projects.
- Low Liquidity: These stocks are often very small, meaning it can be difficult to enter or exit positions without moving the price significantly.
Practical Application for Investors
Modern net-net investors often add secondary filters to Graham’s original formula to avoid “traps”:
- Positive Operating Income: Ensuring the business isn’t actively bleeding cash.
- Low Debt-to-Equity: Confirming the company isn’t burdened by long-term obligations that could wipe out current assets.
- Diversification: Because individual net-nets are risky, Graham recommended holding a basket of 20 to 30 such stocks to let the law of averages work in your favor.