What Is A Net Net Company?
This article on Net Net Company was written by Jialin Chua. Jialin is a corporate finance and a capital markets consultant in Singapore. She uses Net Net Hunter's high performance net net checklist to identify her stocks. Download our net net checklist right now for free. Click Here. Article image (Creative Commons) by Thomas Quine, edited by Net Net Hunter.
What is a net net company? What criteria should we use when judging a net net company?
The game of investing in the stock market is about price and value. Think of the search for a net net company like grocery shopping for the highest quality goods at the best possible price, buying them on sale as often as possible. Hence, a net net company is basically a company that is selling cheaply compared with its asset values, preferably trading at a discount of two-thirds or less of intrinsic value.
Asset-Based Valuation: Net Current Asset Value (NCAV)
Benjamin Graham used the asset-based valuation Net Current Asset Value (NCAV) to guide his individual stock selections. This provides an edge in buying stocks since it’s based on two principles: what’s it worth (intrinsic value), and don’t lose money (margin of safety).
If the estimate of intrinsic value was correct, the net net company could rise 50 percent and still not be overvalued. Also, if the stock market were to hit a rough patch, there was a level of comfort to knowing that what he owned was ultimately worth more than what was paid for.
Net Net Company?
How do we know if the stock we are eyeing falls under this category?
First, we need to determine the price of the whole company by calculating market capitalization.
Market Capitalization Calculation
Market capitalization is calculated by multiplying a company's outstanding shares by the current market price of one share. Since a company is represented by a number of shares, multiplying this with the per share price represents the total dollar value of the company. “Outstanding shares” refers to a company's stock currently held by all its shareholders, including restricted shares owned by the company’s officers and insiders as well as share blocks held by institutional investors. The formula to calculate market capitalization is:
Market Capitalization = Current Market Price (per share) X Total Number of Outstanding Shares
Net Current Asset Value (NCAV) Calculation
Next, we need to calculate how much the company is worth by calculating the Net Current Asset Value – a modified working capital ratio metric that takes into consideration the total liabilities and preferred shares instead of current liabilities.
Net Current Asset Value (NCAV) = (Current Assets - Current Tax Asset - Total Liabilities - Minority Interest - Preferred Shares - Off-Balance Sheet Liabilities)
Market Capitalization vs. Net Current Asset Value (NCAV)
Once we have these two numbers, we can easily determine how much a company is worth and how much the market is pricing the company for. The market capitalization must be at or below the Net Current Asset Value. The general guideline of a net net company is to have the market capitalization at two-thirds or less of the Net Current Asset Value.
Net Net Company: Superior Performance
Here are the monthly returns for the portfolio of net net stocks (NCAV portfolio), NYSE-AMEX index and Small-Firm Index for the time period 1984 to 2008. The monthly returns are grouped by time period to illustrate how this strategy did over different points in time.
The average monthly return for stocks selected using this strategy is 2.55%. The mean monthly returns for the NYSE-AMEX and Small-Firm indices were 0.85% and 1.24%, respectively.
Over a total of nine time periods, there is only one time period (from 1989-1991) that the basket of net net companies posted a lower average monthly return than the market.
|Time Period(Three-Year Periods)||NCAV Portfolio||NYSE-AMEX Index||Small-Firm Index|
|1984 - 1985||1.72%||0.95%||-0.52%|
|1986 - 1988||4.33%||0.89%||0.43%|
|1989 - 1991||0.67%||0.82%||1.27%|
|1992 - 1994||2.79%||1.07%||2.25%|
|1995 - 1997||3.26%||1.78%||1.82%|
|1998 - 2000||3.24%||0.36%||1.16%|
|2001 - 2003||5.02%||1.49%||3.96%|
|2004 - 2006||1.61%||1.34%||1.28%|
|2007 - 2008||-0.12%||-1.95%||-2.24%|
Net Net Stocks Performance from 1984 to 2008 (Source: Benjamin Graham's Net-nets: Seventy-Five Years Old and Outperforming)
On a yearly basis, the NCAV portfolio posted an impressive outperformance of 22.42% over the NYSE-AMEX Index and 16.90% over the Small-Firm Index.
Patience is sometimes the hardest part of using this approach, but if you sit tight, you will be rewarded for buying stocks on the cheap and even beat the market!
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