Intelligent Investor is a book that every investor has heard of, but few have picked up. In the book, Benjamin Graham aka the father of value investing shares a quantitative method to screen for value stocks.
Here’s how it works.
tl;dr
- Net net is a value investing strategy by Benjamin Graham.
- The net net strategy is a quantitative strategy that focuses on a company’s assets instead of its business.
- Using net net strategy, you can find stocks whose liquidation value is greater than their market cap. Such that if they go bust, you still get your money back as a shareholder.
- A graham net net stock is one which is trading below ⅔ of its net current asset value per share.
What is Net Net?
Net Net is a value investing strategy by Benjamin Graham. Net net investing focuses on looking for undervalued companies with enough current assets to cover their liabilities. This means that if the company goes bust, their assets can be liquidated and shareholders still get their money back.
Net net strategy is a quantitative value investing strategy. This means Graham focuses on the company’s financials and ignores its business model.
What is a Graham net net?
“The first rule in calculating liquidating value is that the liabilities are real but the value of the assets must be questioned.”
Benjamin Graham
As an investor looking for opportunities in the Great Depression, Graham’s net net strategy is highly conservative. Hence, the net net strategy focuses on companies trading near liquidation value. If we look at the hierarchy of claims, when a listed company goes bust, retail shareholders are paid last.
Investing in net net stocks means that if these stocks were to go bust, they would have more than sufficient assets to pay all their debtors and enough left over to pay shareholders like us.
What is the criteria for Net Net stocks?
Net Net: Share Price < ⅔ x (Current Assets – Total Liabilities) / Share Price
You may also come across Net current asset value which refers to the value of Current Assets – Total Liabilities.
Graham’s net net strategy only takes the current assets of the company (i.e. assets that can be liquidated within 12 months) into its calculation. All non-current assets are ignored.
As for the liabilities, Graham’s net net strategy considers all liabilities and debts, aka liquidation value.
When to sell net net stocks?
Although in theory, these net net companies can pay shareholders if they are liquidated, in reality, some could just cruise while others may be sold at a discount.
Hence, Graham uses a sell rule of 50% profit or a 2 year holding period, whichever earlier.
How to screen for net net stocks?
There are paid and free net net stock screeners available online. Some examples include Net Net Hunter, Graham Value and Finviz.
You could also use tools like tradingview and Yahoo Finance to get the Current Assets, Total Liabilities, Number of outstanding shares and Current share price of listed companies, then use excel to work out the Net Net value of any stock listed in any country, using the formula above.
Here’s a simple Google Drive sheet you can use to screen for net net stocks in any markets, just simply input the latest Current Assets, Total Liabilities Share Price and No. of Outstanding Shares columns.
Net Net stocks tend to be more difficult to find in certain countries or when the markets are bullish.
Downsides to Net Net investing
While net net investing is a viable value investing strategy, even in today’s markets (we have shared some net net stocks from Japan previously), there are downsides to the strategy.
Let’s take a look at the disadvantages of net net investing:
1) Unsexy, unfamiliar stocks
Due to its conservative criteria, net net stocks tend to be smaller, unfamiliar stocks. This can be uncomfortable for some investors as investing in unheard of stocks could be an unnerving experience.
The FANNG stocks or even today’s Berkshire Hathaway will never make it into the net net stock list.
2) It will take time for net net stocks to deliver return
Net net stocks are usually priced as such because the market thinks that the company is plagued by long term issues with negative impact.
It could take a while before a net net stock delivers returns, if it ever does. Hence, the sell rules mentioned above.
At this point, you may also be wondering:
“So why isn’t Warren Buffett using net net investing?”
The main reason is: Size.
Due to the size of Berkshire Hathaway’s capital, many net net stocks do not meet their investment criteria as Berkshire might end up buying over the company.
But a major weakness in this approach gradually became apparent:
Buffett in 2014 shareholder letter
Cigar-butt investing was scalable only to a point. With large sums, it would never work well.
Do net nets still exist?
While the economy today differs wildly from the times when Benjamin Graham was investing, net net stocks can still be found. However, you will need to be willing to explore international markets, and be comfortable investing in unfamiliar stocks.
We shared some Japan net net stocks here.