Do you want to invest in stocks but don’t have much money to do so? You should consider net-nets. Given their deep value, net stocks can give you excellent returns.
Contrary to popular belief, investing in net-nets is very easy. Below, you’ll find in-depth information on net net stocks and how they can serve as your passport to earning good money.
How Investing in Net-Net Stocks Started?
Net-nets are the brainchild of the author Benjamin Graham.
In the 1930s, he was working on a new investment strategy. It then dawned on him that an entity’s net current asset value was representative of its real-world liquidation amount.
Benjamin Graham’s net-net stocks have become so appealing that they caught the eye of prolific investor Warren Buffett. He called net nets ‘cigar butts’ because they were unattractive but highly profitable.
Often, a net-net stock belongs to a company that most people deem not worth investing in. However, they’re selling stocks at lower than the relative value that buying them is similar to seeing an ‘unfinished cig’ on the street. It’s free to pick up, so the extra puffs you get from it will bring nothing but profit.
What are Net-Net Stocks?
A net-net stock is a type of low price-to-book (P/B) stock. But the B in P/B has its long-term assets removed.
Doing so transforms the book value into net current asset value (NCAV). This strategy is useful for value investors as it helps them calculate a conservative estimate of the company’s liquidation value.
Apart from Benjamin Graham’s net-net stocks, another thing to try is the NNWC or the net-net working capital stock. While it is somehow similar to net-nets, it’s derived by discounting assets before deducing the liabilities, off-balance sheet liabilities, and preferred shares.
Based on this guide to deep value investing, the discount amounts usually are as follows:
- Cash and Equivalents – 100%
- Short-term investments – 90%
- Receivables – 75%
- Inventories – 50%
- Prepaid expenses – 25%
- Deferred tax assets – 0% (no discount)
How is NCAV Calculated?
Your success in investing in net-nets depends on your ability to calculate the NCAV. Fortunately, this how-to guide to net-net stocks can help you do that. All you just need to do is follow this formula:
Current Assets MINUS Total Liabilities (including Off-Balance Sheet Liabilities) and Preferred Shares = NCAV
As for the price to NCAV, divide the Market Capitalization figure with the NCAV number.
To interpret: the lower the ratio is, the cheaper the net-nets stock.
While it’s easy to solve for the net current asset value, the company may increase or decrease it by issuing or buying back its shares.
As it can change the value of current assets, you should compute the price to NCAV for the investment by dividing the cost of the common share by the NCAV per common share.
How Do I Find Net-Net Stocks?
Without a doubt, net-nets can help you make dollars out of pennies. But you can only become successful if you’re careful in net investing.
That said, you need to follow these tips on how to find the best net-net stocks.
Stay Within Your Net Investing Circle:
If you are new to net-nets, stick with what you know.
While you may be tempted to go for one of the riskiest stocks, don’t. There are so many things that can go wrong, so the best way to do it is to remain within your circle.
Beware of the Chinese Net Stock Strategy:
A lot of people can see the stock and its value of 1000% growth. However, if it’s too good to be true, it probably is.
This is especially the case with Chinese stocks. They pose a big risk, so if you plan to invest in a great deal of money, better stay away from Chinese companies unless the stock is from Alibaba.
Choose the Company with a Good Net Working Capital:
It’s not enough to look at balance sheets and current assets. When it comes to net-nets, stay away from companies with outdated models. There is no value in investing in them as they are bound to fail soon.
See if the Company Has Low Cash Burn:
Given the state of the market, your net strategy should focus on deep value investing. The best way to go is to invest in entities with money for the years to come, even if they’re losing some now.
To do this, you need to obtain the last year’s figures and divide them with the money remaining on the balance sheet. Another strategy is to look at the company average for two years.
Since deep value investing is not without risks, it’s still better to be safe than sorry. Even if the market right now is rock solid, prudence will keep you afloat in the long term.