Will The Net-Nets Rule The Day?

By Eric Fox | March 06, 2009 AAA

The latest fall in the stock market, to levels not seen since 1996, has created a new class of net-net stocks. These stocks are exciting hard-core value investors, who see opportunity in owning some of these big-name net-net stocks. Investors should be cautious, however, as some of these names may deserve to trade at such cheap valuations.

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Benjamin Graham Lives
A net-net stock is a slang term for a company that is selling below its net current asset value (NCAV). This is calculated as the total of a company's current assets less its total liabilities (long and short term), expressed on a per share basis. This NCAV per share is then compared to its stock price. Some investors advocate buying stocks selling below their NCAVs, because the price paid incorporates a margin of safety.

The theory is that a company can be liquidated and its current assets, which presumably consist of cash and assets easily convertible to cash, can be used to satisfy all liabilities. The strategy was originally attributed to Benjamin Graham, although he advocated diversification and selectivity in purchasing net-net stocks. (Learn about the man who taught investing to the Oracle of Omaha, Warren Buffett. See The Intelligent Investor: Benjamin Graham.)

These are four stocks trading below NCAV:

Company Current Assets Total Liabilities NCAV per Share Mkt. Price PCT
Skechers USA
(NYSE:SKX)
$602M $208M $8.55 $5.46 64%
Tech Data
(Nasdaq:TECD)
$4.77B $3.30B $29.28 $16.88 58%
Benchmark
Eletronics

(NYSE:BHE)
$1.16B $0.38M $11.98 $9.09 76%
Electro
Scientific
(Nasdaq:ESIO)
$310M $47M $9.71 $5.06 52%
As of market close March 5, 2009

The New Net-Nets
Skechers
(NYSE:SKX) sells at 64% of its NCAV. According to this investment strategy, Skechers is an extremely attractive option, as its NCAV implies that the company can be liquidated and all liabilities paid off with room to spare. The reality, however, is that parts of the current assets are inventory, which can almost never be liquidated at 100% of their balance sheet value. During the SKX conference call, management confirmed this problem and said "we began managing our inventory levels down at reduced prices and took reserves of over $15 million."

One of the largest capitalization net-net stocks trading in the marketplace is Tech Data Corp. (Nasdaq:TECD), which trades at 58% of NCAV. The company just reported GAAP net income per share of $1.17 in its first fiscal quarter, which ended Jan. 31, 2009. The company is a distributor of information technology products.

Net-Net Value
Benchmark Electronics (NYSE:BHE) is a contract manufacturer that also trades below NCAV, but at a less attractive level of 76%. The company just reported a large loss for the fourth quarter of 2008, and full year 2008, due to a write-down of goodwill with a $247 million impairment charge. (Read more in Impairment Charges: The Good, The Bad and The Ugly.)

Electro Scientific Industries (Nasdaq:ESIO) is a supplier of capital equipment to the semiconductor industry, and trades at a steep 50% of NCAV. Even more attractive is that the company had $165.74 million in cash and short-term investments at the end of 2008, although $7.1 million of this is tied up in auction rate securities. This cash balance actually exceeds its market capitalization of $138 million. The company also lost $1.08 on GAAP basis in 2008.

True Value
Although the stock market is chock full of stocks trading below net current asset value, many of these are unprofitable or have current assets tied up in non-liquid assets that shouldn't be valued at 100% of balance sheet amounts. Investors should do more research before jumping into these net-nets.

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