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. Net net 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. Net-net value is calculated by deducting total liabilities from the adjusted current assets.
- The net-net value investing strategy uses a company’s net current asset value for valuation purposes. Net current asset value is a company’s cash, adjusted accounts receivable and inventory, less total liabilities.
- focuses on current assets, cash and cash equivalents, accounts receivable, and inventory for valuation purposes.
- The net-net investing strategy does not take into account long-term liabilities or other tangible assets, making it unreliable for long-term investments.
- 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.
- According to the net-net strategy, the ability to collect cash is the true value of a business.
- Net-net stocks may not be a reliable long-term investment strategy because management teams rarely choose to fully liquidate the company at the first sign of trouble.
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.
Net-net working capital is calculated as cash and short-term investments + (75% of accounts receivable) + (50% of inventory) - total liabilities.
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.
Criticisms of Net-Net
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 into 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 gone under or been acquired at a discount.
The net-net strategy of finding companies with a market value below its net-net working capital may be an effective strategy for small investors. Net-net companies are sought after by day traders which may contribute to their rise in month-to-month valuation.