Net-Net Valuation: Definition, How It Works, and Calculation Formula

A comprehensive guide to Net-Net Valuation, a technique in value investing established by Benjamin Graham. Learn about its definition, working principles, and the formula used for calculation.

Net-Net Valuation is a value investing technique developed by Benjamin Graham, often regarded as the father of value investing. This method involves valuing a company based solely on its net current assets, disregarding long-term assets and liabilities. It hinges on the principle that such companies are undervalued and therefore present a buying opportunity for investors.

Understanding How It Works

Principle of Net-Net Valuation

In Net-Net Valuation, the focus is strictly on the company’s liquid assets, specifically its current assets minus total liabilities. The essence of this technique is to identify stocks trading below their Net Current Asset Value (NCAV), which provides a “margin of safety” for the investor.

Steps in Net-Net Valuation

• Determine Current Assets: Identify the total current assets from the company’s balance sheet.
• Subtract Total Liabilities: Deduct the total liabilities to find the net current assets.
• Compare with Market Cap: Compare the net current assets with the company’s market capitalization.
• Invest if Undervalued: Invest in stocks where the market cap is less than the NCAV, suggesting they are undervalued.

Formula to Calculate Net-Net Valuation

The formula for calculating Net Current Asset Value (NCAV) is straightforward:

$$ \text{NCAV} = \text{Current Assets} - \text{Total Liabilities} $$

If a company’s stock price per share is less than its NCAV per share, it may be considered a net-net investment opportunity.

Example Calculation

Let’s consider a hypothetical company with:

• Current Assets: $1,000,000
• Total Liabilities: $700,000
• Number of Shares Outstanding: 100,000

Using the formula:

$$ \text{NCAV} = \$1,000,000 - \$700,000 = \$300,000 $$

$$ \text{NCAV per Share} = \frac{\$300,000}{100,000} = \$3 $$

If the stock is trading below $3 per share, it may be a potential net-net investment.

Historical Context and Applicability

Origins

Benjamin Graham introduced the Net-Net Valuation concept in the early 20th century as part of his broader value investing philosophy detailed in his books like “Security Analysis” and “The Intelligent Investor”.

Modern Application

While the technique was more prevalent during Graham’s era, it remains relevant today, particularly in bear markets or during economic downturns when more companies might trade below their NCAV.

Comparisons and Related Terms

Value Investing

Net-Net Valuation is a subset of value investing, where investors seek undervalued stocks based on intrinsic values.

Price-to-Book Ratio

While both consider asset values, the Price-to-Book Ratio looks at total asset values including fixed assets, unlike the NCAV which only considers current assets.

FAQs

Is Net-Net Valuation Suitable for Modern Markets?

Yes, although opportunities may be less frequent, net-net valuation can still identify undervalued stocks, particularly in small-cap or micro-cap companies.

How Risky is Net-Net Investing?

While it provides a margin of safety, it can be risky as companies trading below NCAV often have underlying issues or are in distress.

Are There Automated Tools for Net-Net Valuation?

Several financial analysis platforms and stock screeners offer filters to identify net-net stocks.

References

1. Graham, B., & Dodd, D. “Security Analysis”.
2. Graham, B. “The Intelligent Investor”.
3. Financial Analysis Platforms (e.g., Morningstar, Bloomberg).

Summary

Net-Net Valuation remains a proven strategy for discerning investors seeking opportunities in undervalued stocks. By focusing on net current assets, this technique provides a margin of safety, critical for navigating volatile or bear markets. Though rooted in historical financial principles, its application continues to help investors identify value in the modern marketplace.