Definition
In finance, “net-net” is an investing strategy that values a company primarily on its net current asset value (NCAV). The net-net method subtracts total liabilities from a company’s current assets to determine the firm’s financial position. The strategy disregards the company’s future earnings potential and provides a conservative estimate of its intrinsic value.
Key Takeaways
- Net-Net is a value investing technique developed by Benjamin Graham, used to find extremely undervalued companies. It considers only cash and short-term investments, receivables, and inventory in its valuation.
- The formula for Net-Net is: (Cash and Short-Term Investments + 75% of Accounts Receivable + 50% of Inventory) – Total Liabilities. The resulting value, if less than the company’s market capitalization, indicates the stock may be undervalued.
- The Net-Net strategy comes with high risk as it often identifies companies in financial distress. However, the deep discounts may provide a margin of safety for investors. It is rarely used alone but can be a powerful tool combined with other analysis methods.
Importance
Net-Net is a crucial financial term primarily used in value investing, where it refers to a valuation technique that subtracts both accounts payable and accounts receivable from a company’s current assets, meaning only the ‘hard’ or ‘tangible’ assets are considered.
It is crucial because it gives investors a very conservative measurement of a company’s fundamental value, focusing on immediate liquidation value and allowing them to make investment decisions accordingly.
Net-net helps investors identify companies priced less than their net current asset value, which could signal undervalued investment opportunities.
Therefore, Net-Net plays a significant role in corporate finance and investment decision-making processes.
Explanation
The term Net-Net is a value investing technique that was first introduced by the legend of long-term investing, Benjamin Graham. Its main purpose is to identify and invest in companies that are extremely undervalued. Essentially, net-net focuses on the company’s current assets and liabilities to assess its underlying value.
It serves as an important tool for investors who are searching for bargains, as it helps them identify stocks that are priced at a deep discount to the value of their assets. Net-Net is used to evaluate a company’s net current asset value (NCAV), which should be lower than its market value. Calculation of NCAV is relatively simple; it involves subtracting total liabilities from total current assets, and ignoring the long-term assets.
If the resultant figure is higher than the company’s market cap, then the stock is considered to be undervalued. In theory, if a company’s share price drops below its NCAV per share, an investor could make a profit by buying the company’s stock, assuming the company went into liquidation. However, finding companies that meet this criterion is rare and the technique should be used with caution, as it may also indicate that the company is in financial distress.
Examples of Net-Net
“Net-Net” is a value investing technique developed by Benjamin Graham, in which investors select companies on the basis of their Net Current Asset Value (NCAV). Essentially, the companies are selected if their market capitalization is lower than their NCAV. Here are three real-world examples:
In 2012, Tech Data Corp., a large wholesale distributor of tech products, came under investors’ radar because it was trading below its net-net value. Its share price had fallen drastically due to an accounting scandal, but the underlying business was still yielding significant cash flows larger than its market cap.
In 2005, Tweeter Home Entertainment, a consumer electronics retailer, faced liquidity issues and was trading under its net-net value. Investor Schultze Asset Management recognized this and took a significant position in the company. A few years later, the company was sold to another private equity firm, realizing a substantial profit for Schultze Asset Management.
Driven by the 2008 financial crisis, Pier 1 Imports, a retail store chain, saw its shares dropping significantly below its net-net value. They were able to figure out their financial issues over time and ultimately the stock regained its value providing investors with substantial returns who had purchased at net-net prices.
FAQs on Net-Net
What is Net-Net?
Net-net is a value investing technique developed by Benjamin Graham, in which a company is valued based solely on its net current assets. The net-net investing strategy looks for firms where the total cash and short-term investments, minus all liabilities and obligations, divided by the firm’s number of shares outstanding, results in a value that is significantly less than the company’s market capitalization.
How can I calculate Net-Net?
Net-Net is calculated by subtracting a company’s total liabilities from its current assets, where ‘current assets’ are those which can be converted into cash within a year. This is primarily Cash, Receivables and Inventory. Total Liabilities include both Long Term and Current Liabilities. If Net-Net per share is less than the current share price, the company may be undervalued.
What are some limitations of the Net-Net approach?
The net-net approach has its drawbacks. It can undervalue certain assets such as property or plant and machinery which can be sold for value but is not defined as a current asset. Also, it disregards intangible assets such as patents, copyrights and brand value which can provide a significant amount of worth for a business. Therefore, while the net-net approach can be effective in identifying companies producing tangible products with little long-term debt, it may undervalue companies with significant intangible assets or in service industries.
Who developed the Net-Net strategy?
The Net-Net strategy was developed by Benjamin Graham, the father of value investing. Benjamin Graham was a British-born American economist, professor and investor. He is widely known as the “father of value investing,” and wrote two of the most famous financial texts ever: Security Analysis, with co-author David Dodd, and The Intelligent Investor.
Related Entrepreneurship Terms
- Current Asset
- Current Liability
- Book Value
- Liquidation Value
- Value Investing
Sources for More Information
- Investopedia: A reliable source for financial and investing explanations.
- Bloomberg: Offers news, data, and analysis covering finance and global markets.
- Reuters: Provides breaking news in business, finance, and investing.
- The Balance: Offers expert insights on mastering your money and navigating career choices.
