TL;DR: A net-net is a share that trades below its net current asset value per share (NCAV = current assets minus total liabilities, divided by the number of shares). Graham applied an extra margin of safety and bought only below two thirds of that value. Such shares are rare and often belong to companies in trouble.
What can you expect?
- Time per week
- Searching and calculating candidates takes several hours per week. Afterwards you follow the positions periodically.
- Starting capital
- You need enough money to spread across several positions without costs weighing too heavily. Use only money you can do without for years.
- Typical setbacks
- Shares that stay cheap for years, companies that lose assets, bankruptcies and positions that are hard to exit. A single share can be lost entirely.
- Costs
- Order fees, wide spreads on thinly traded shares, currency costs and possibly data fees. Compare broker costs for the exchanges you want to trade on.
- Not suitable if…
- Not suitable if you have little time, do not want to read balance sheets or get stressed by individual losses.
How it works
The net-net method compares a company's market value with its net current asset value (NCAV): current assets minus all liabilities. If a share trades well below that value, in theory you buy a lot for little. Benjamin Graham described this in his investing books. Practice is harder: such companies are usually small, thinly traded and often have real problems. A low price can be deserved. This is an explanation of the method, not advice and not an expected return.
Core principles
- 1. Use a cautious value: current assets minus all liabilities, fixed assets do not count
- 2. Demand a margin of safety: buy only well below the calculated value
- 3. Diversify across several positions, because individual companies can fail
- 4. Check the quality of the figures: inventory and receivables are worth less than cash
Step-by- step plan
- 1
Learn to calculate NCAV
Take a company's balance sheet. Add up current assets and subtract all liabilities. Divide by the number of shares outstanding.
- 2
Search for candidates
Use a screener or financial database to find shares trading below NCAV per share. Check every candidate yourself.
- 3
Apply haircuts and a margin of safety
Value receivables and inventory more cautiously than cash and demand a margin of safety, for example buying below two thirds of your cautious NCAV.
- 4
Assess quality
Check whether the company is losing money, must refinance debt or is burning cash. Read about management and possible dilution.
- 5
Diversify and limit position size
Keep each position small and spread across several companies. Decide in advance when you will exit.
In detail
The idea: value you can count
Graham looked for investments where the price was far below a cautious estimate of value. With net-nets you do not look at future profit, but at the short-term assets on the balance sheet.
NCAV counts only current assets: cash, receivables and inventory. All liabilities are deducted, including long-term ones. Factories, buildings and brand value do not count. The result is a bare floor showing roughly what would be left if the company sold everything and paid its debts.
The 'cigar butt' image (one last puff from a discarded cigar) comes from Warren Buffett and describes cheap companies without growth.
The calculation and its weak spots
NCAV = current assets - total liabilities. Divide by the number of shares for NCAV per share. Graham bought only at a price below two thirds of that amount.
The weak spot is the balance sheet itself. Cash can be trusted. Receivables may go unpaid. Inventory may be obsolete or have to be sold at a discount. That is why many investors apply haircuts: for example 100% of cash, 75% of receivables and 50% of inventory. There is no fixed rule; the choice is a judgement.
Also check whether the company is losing money. A company with yearly losses eats into its own assets.
Why such shares exist
Why do shares trade below their net assets? Usually because the market sees problems: losses, little growth, uncertain management or a weak market. Many of these companies are also too small or too thinly traded for large investors. That can create opportunities, but it also means you cannot easily buy or sell.
The price may also be deserved. Sometimes a company 'consumes' its assets before the price recovers. That is why diversification and a critical look at the figures matter.
Practical limits for retail investors
For a retail investor there are a few practical obstacles. True net-nets are rare and often found among small listed companies, sometimes in countries where trading is less convenient. Information is limited and spreads are wide. You therefore need several positions to spread risk, and that raises costs.
It is also labour-intensive: you read balance sheets and annual reports and follow the companies. For many investors a broadly diversified fund is a simpler alternative. Use net-nets only with money you can afford to lose and weigh your knowledge and time honestly.
- Ability to read a balance sheet
- Patience and discipline
- Acceptance that individual positions can fail
- Balance sheets and annual reports
- Stock screener
- Spreadsheet to calculate NCAV
- 01 The price is below two thirds of NCAV per share (the margin of safety Graham used)
- 02 You have checked the quality of inventory and receivables and applied a discount where needed
- 03 The company has no acute bankruptcy risk and cash flow is not structurally and strongly negative
- 04 The position fits your diversification and you can buy the share at acceptable cost
- 01 The price approaches NCAV or the company is valued above its assets
- 02 The figures deteriorate and the calculated value falls below your purchase price
- 03 You reach a holding period set in advance and the situation has not improved
- 04 The company goes bankrupt, is delisted or receives a takeover bid
Worked example
Hypothetical example (all amounts are assumed). Company Y, amounts in millions of euros, 4 million shares.
- Current assets: cash 10 + receivables 15 + inventory 25 = €50
- Total liabilities: €22
- NCAV = 50 - 22 = €28
- NCAV per share = 28 / 4 = €7.00
- Purchase limit with margin of safety (2/3) = 7.00 x 2/3 = €4.67
If the share trades at €4.00, it trades at 4.00 / 7.00 = 57% of NCAV, so 43% below it.
Now with haircuts on the balance sheet (100% cash, 75% receivables, 50% inventory):
- 10 + 0.75 x 15 + 0.5 x 25 = 10 + 11.25 + 12.5 = €33.75
- Minus liabilities 22 = €11.75, so €2.94 per share
- With margin of safety (2/3) = €1.96
The cautious version is far below the €4.00 price. The difference shows how sensitive the outcome is to your assumptions. Moreover a positive NCAV does not count if the company loses money: if it loses, say, €5 million per year, NCAV is noticeably lower after a few years.
This calculation example is not an expectation and not a recommendation.
Hypothetical example, not advice.
Work it out yourself
Risks and risk management
- Value trap: the share is cheap because value really is falling, for example through losses that eat the assets
- Limited tradability: wide spreads and difficulty buying or selling
- Asset quality: inventory may be obsolete and receivables may go unpaid
- Dilution, poor governance or a delisting can make the share worth less
- Keep any single position small so a bankruptcy does not hit your portfolio
- Diversify across several companies and countries, but watch currency and exchange risk
- Apply discounts to receivables and inventory and use a wide margin of safety
- Use limit orders and watch the cost of buying and selling
Learn the basics
Key takeaways
- NCAV is a cautious estimate: current assets minus all liabilities. Fixed assets and future profit do not count.
- Graham used an extra margin of safety: buying below two thirds of NCAV.
- Cheap is not the same as valuable. Many net-nets are companies in trouble.
- True net-nets are rare, small and hard to trade. For many investors this is not practical.
Frequently asked questions
How do I calculate the NCAV of a share? +
NCAV = current assets minus total liabilities. Divide by the number of shares outstanding for NCAV per share. You find the data in the balance sheet in the annual or quarterly report. Graham bought only below two thirds of that amount, as an extra margin of safety.
Can net-nets still be found in Europe? +
They are uncommon and often small and hard to trade. Their number varies with the market period. Screeners can help you search, but always check the balance sheet yourself. Finding a net-net is no reason to buy.
Why do many net-nets fail? +
Shares usually trade low because the market sees problems, such as losses, an outdated model or poor governance. Some companies eat into their assets or go bankrupt. Diversification limits the effect of a failure but does not remove the risk.
Origin
Devised by / based on: Benjamin Graham . Source: Benjamin Graham & David Dodd, Security Analysis (1934); Graham, The Intelligent Investor (1949)