Benjamin Graham came up with the idea of the ‘net-net’ stock in his seminal text
Security Analysis.
The idea behind the net-net is simple: you’re looking for stocks trading below their liquidation value. Graham defines liquidation value as a company’s current assets exceeding its total liabilities.
Companies can quickly convert current assets into cash, so at the core, the question is: can management liquidate this company at a profit given today's share price?
The simple formula is as follows:
- Net Current Asset Value = Current Assets - Total Liabilities
- Price/NCAV = Market Cap / Net Current Asset Value
- If the above value is below 0.66, then the company qualifies as a net-net.
Net-nets tend to be in the worst industries, think newspapers and payphone operators; their financials are often abysmal, and management has little incentive to change things. Modern-day net-nets unquestionably come with their fair share of baggage.
Net-net investing is mostly quantitative in nature--crunch the numbers and buying a basket of net-nets has been a better historic bet than trying to do rigorous research of the individual companies.
Prior to the crash, there were very few US-based net-nets available, and all of them were plagued with the worst of problems. Below is a chart showing the number of net-nets available up to 2009.
Post-crash, however, the amount of net-nets has nearly doubled overnight. The great thing is, some of these are actually halfway decent businesses, especially compared to the poor quality of net-nets you'd find in a bull market.
Historical Performance of Net-Nets
There are a few prominent studies of the efficacy of the net-net investing strategy. Market dynamics have shifted significantly since the publishing of many studies, making their utility questionable.
We’ll shift our focus to the most available modern example, which is James Montier’s backtests of the strategy in his 2008 research paper “Net-Nets: Outdated or Outstanding?” which was later published in his book Value Investing: Tools and Techniques for Intelligent Investment.
The below chart shows the returns of net-nets versus the broad market indexes.
Throughout this article, we're going to take a look at some of the new net-nets created by the recent coronavirus crash, but first, we'll show you how to screen for your own net-nets.
How To Find Net-Net Stocks
Most stock screeners don’t have Net Current Asset Value (NCAV) available in their screening criteria. The first step is finding the right tool for the job.
In my experience, the two that stand out are Finbox and Fintel. Each offers tons of customization. Finbox is much more user-friendly, while Fintel offers more customization, allowing you to pseudocode your screens.
Because of how rare net-nets are in the modern stock market, it’s best to set a pretty wide net. Regardless of how you customize your screen, you’ll be left with a manageable list of stocks to analyze.
Below is a screenshot of my screen.
- Ensure Price/NCAV is between 0.1% and 66%
- Exclude companies domiciled in China
- Listed on a major American exchange or the TSX (major Canadian exchange)
NCS Multistage Holdings (NASDAQ: NCSM)
NCSM provides engineering technology to oil & gas companies. Most of their revenue comes from their fracturing systems, which basically make the process of fracking easier.
Already on the downtrend, the coronavirus did a number on NCSM, still down about 40% from February 27th. This was enough to put NCSM into net-net status.
The company's current assets rack up to $103 million, with $42 million of that accounting for accounts receivable. The quality of that AR is questionable, given the state of the US energy market post-coronavirus and post-price wars. Their total liabilities stand at $43 million since their last 10-Q filing.
It seems the market overlooked a significant cash payment due to NCSM, in any case. On March 17th, one of the company's 50% subsidiaries won a $34.4 million award in a licensing lawsuit. Amid the indiscriminate coronavirus panic selling, the market appears to have completely missed this, as evidenced by the stock's lack of activity on the announcement date.
For a $29M company, you’d think that an approximately $17.2 million cash payment would change the value materially.
Hudson is a recruiting firm which was initially a Monster.com subsidiary in the early 2000s, before spinning off.
They sell themselves as a Total Talent Solutions firm, which basically means they specialize in assisting companies in acquiring talent through a myriad of working styles--whether that's full-time workers, part-time workers, or freelancers.
Between most of their business coming from Asia and the fact that companies have throttled hiring globally, they’ve certainly taken a hit from coronavirus.
As of their last 10-Q, the company has roughly $26 million in cash and $8.8 million in total liabilities, enabling them to weather some hard times. With a market cap of just $23.6 million, their cash balance currency outweighs their market cap.
Additionally, the CEO both expects the first quarter of 2020 to outshine Q1 2019, even amid the pandemic, and just negotiated to buyback 9% of their shares.
Final Thoughts
For the most part, the US indexes have already made their “V-shaped” recovery, which can be deceiving. The market is certainly not back to normal, with Big Tech doing most of the heavy lifting.
As this article has demonstrated, there’s still plenty of deep value to be found, post-crash.
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