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 method focuses on current assets, taking cash and cash equivalents at full value, then reducing accounts receivable for doubtful accounts, and reducing inventories to liquidation values. Total liabilities are deducted from the adjusted current assets to get the company's "net-net" value.
Understanding Net-Net Investing
Graham used this method at a time when financial information was not as readily available, and net-nets were more accepted as a company valuation model. When a viable company is identified as a net-net, the analysis focused only on the firm’s current assets and liabilities, without taking other tangible assets or long-term liabilities into account. Advances in financial data collection now allow analysts to quickly access a firm’s entire set of financial statements, ratios and other benchmarks.
Essentially, investing in a net-net was a safe play in the short term because its current assets were worth more than its market price. In a sense, the long-term growth potential and any value from long-term assets are free to an investor in a net-net. Net-net stocks will usually be reassessed by the market and priced closer to true value in the short-term. Long-term, however, net-net stocks can be problematic.
Potential Drawbacks with Net-Net Stocks
The reason net-net stocks may not be a great long-term investment is simply because management teams rarely choose to fully liquidate the company at the first sign of trouble. In the short-term, a net-net stock may make up the gap between current assets and market cap, but over the long-term an incompetent management team or a flawed business model can ruin a balance sheet quite rapidly. So a net-net stock may find itself in that position because the market has already identified long-term issues that will negatively affect that stock. For example, the rise of Amazon has pushed various retailers in to net-net positions over time and some investors have profited in the short-term. In the long-term, however, many of those same stocks have went under or been acquired at a discount.
Factoring in Current Assets for Net-Net
Current assets, which are used in the net-net approach, are defined as assets that are cash, and assets that are converted into cash within 12 months, including accounts receivable and inventory. As a business sells inventory, and customers submit payments, the firm reduces inventory levels and receivables. This ability to collect cash is the true value of a business, according to the net-net approach. Current assets are reduced by current liabilities, such as accounts payable, to calculate net current assets. Long-term assets and liabilities are excluded from this analysis, which only focuses on cash that the firm can generate within the next 12 months.