The Net-Net Bet

[Lizard]

Not too long ago, I read the following post by Roger Montgomery:

Should a Value Investor Imitate Ben Graham?

He refers to the following investment method:

Ben Graham advocated a mostly, if not purely, quantitative approach to finding bargains. He sought to buy businesses trading at a discount to net current asset values – what has been subsequently referred to as ‘net-nets’. That is, he sought companies whose shares could be purchased for less than the current assets – the cash, inventory and receivables – of the company, minus all the liabilities.

He concludes that:

Many investors cling to the Graham approach to investing even though some, if not many of his brightest and most successful students, moved on decades ago.

I found it somewhat odd to think there is a silent bevy of value investors out there looking for "net-nets" - personally, my impression has been that value investors have been looking at a lot of different parameters in the last few years - P/E, yield, ROE, PEG and even EV/EBITDA always seem to get many more mentions than net working capital. And for at least 5 years prior to 2007 (and perhaps more like 15), it seemed almost impossible to find a company that fitted the Ben Graham description - particularly not one that was booking a profit.

Now since this is one of those rare occasions in my investing career when it might be possible to find enough net-nets, I thought perhaps we should test this!

Roger is comparing against his own, mostly ROE-based, style of investing. I thought it would be interesting to find perhaps 10 net-nets and test their performance. (I haven't quite decided what to compare with - perhaps Roger's Valueline portfolio, although that varies in composition).

However, I need help to find more Net-Nets - all they need is lots of current assets, not many liabilities and a market cap that is going to be less than the difference (i.e. start by looking for low NTA).

So far, in the "net-nets" department, I have the following:

AMO - $0.40 - market cap $12.3m, current assets - total liabilities = $17.3m
CPI - $0.29 - market cap $17.9, current assets - total liabilities = $46.2m
ESS - $0.19 - market cap $9.9m, current assets - total liabilities = $14.0m

Any suggestions welcome!

[h2so4]

Careful Lizard, you maybe inviting a P chart onslaught.

[Lizard]

Careful Lizard, you maybe inviting a P chart onslaught.

Wow!

Time for a break...

[Snoopy]

However, I need help to find more Net-Nets - all they need is lots of current assets, not many liabilities and a market cap that is going to be less than the difference (i.e. start by looking for low NTA).

NZS - $0.44 - market cap $NZ107.5m, current assets - total liabilities = $US162.0m or $NZ231.4m

based on a $NZ1 = $US0.7 exchange rate

SNOOPY

[Lizard]

Thanks Snoopy, much appreciated... I will take a look!

I did consider CSS, but I am not really willing to count the valuation of biological assets under IFRS as being equivalent to the valuation methods of Ben Graham's day.

[shasta]

Thanks Snoopy, much appreciated... I will take a look!

I did consider CSS, but I am not really willing to count the valuation of biological assets under IFRS as being equivalent to the valuation methods of Ben Graham's day.

Liz

Have a look at the MLM thread, is that the kind of company you're after?

[drew]

Correct me if im wrong but thought the Net-Net investment is where the market cap that is 2/3rds or less of working capital to give a sufficient margin of safety?

[Lizard]

Hi Shasta,

The main criteria for a net-net is that if total liabilities are subtracted from current assets, the remainder is greater than the market cap. In the case of MLM, I get the difference of $22.7 - $9.2 = $13.5m, while market cap is $27.5m, so it wouldn't pass the hurdle.

Ideally (if I was actually going to be buying them), I'd also want companies that expected to be profitable in the current period. However, I'm not sure if I will find enough of them for this experiment! So I'm interested to follow the progress of any shares that pass the net-net test.

[Lizard]

Correct me if im wrong but thought the Net-Net investment is where the market cap that is 2/3rds or less of working capital to give a sufficient margin of safety?

I think in Ben Graham's case, his team typically purchased at two-thirds of net working capital, but I don't think it was an exact criteria.

I'm not so fussy - if I actually decided to buy any, they'd have to jump a few more of my own hurdles first anyway. This is just a paper-based exercise and still not sure we'll find enough stocks for this experiment.

[CJ]

However, I'm not sure if I will find enough of them for this experiment! So I'm interested to follow the progress of any shares that pass the net-net test.

In the information age, and with limited amount of options (in NZ at least) I wonder if it will be possible.