Net Nets: What are they and why would you care about them?

#investing #stocks #net-nets #ncav #bengraham #warrenbuffett #outperformance #highreturns #lowrisk
Net Nets is an investment strategy, that has historically outperformed the market, with returns between 15 and 38 percent per year.

Net-Nets describes a stock investment strategy involving buying undervalued stocks below their net current asset value (NCAV). Historically, this approach has outperformed the market, with returns ranging from 15 to 38 percent per year. Net-nets offer a deep discount to intrinsic value, a margin of safety, catalysts for change, and benefit from being overlooked by the market.

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The term Net Nets describes a specific investment strategy that involves buying stocks that are trading at a discount to their liquidation value. The first "net" in "net net" refers to the concept of net current asset value, which is a company's current assets minus its total liabilities. It is the amount of money that would be left over if a company were to sell all its assets and pay off all its debts and it is an approximation of the liquidation value of the company. The second "net" in "net net" refers to the fact that the stock is trading below that liquidation value, indicating that the market is valuing the company at less than the value of its net current assets.

So the double "net" in net-net emphasises the idea that the company has a very healthy balance sheet and that it is not only undervalued by the stock market but deeply undervalued based on its liquidation value. Sometimes, net net investors call themselves deep value investors for that reason.

But why would you care?

Investing in net-nets has historically generated market-beating returns. Whereas the American S&P 500 stock index has compounded at eight point eight percent per year since 1985, investing in net-nets instead has returned between 15 and 38 percent per year, depending on the market in which the net-nets were identified and the time frame of the study.

This massive outperformance has been shown in many different studies and seems to persist for several fundamental reasons:

  1. Deep discount to intrinsic value: As net-nets are stocks that trade below their net current asset value (NCAV), they are essentially being sold at a deep discount to their intrinsic value. This means that the potential upside for investors is significant if the company's fundamentals improve or if the market recognizes the true value of the assets.
  2. Margin of safety: By buying stocks at a significant discount to their NCAV, investors can establish a margin of safety, which means that there is a lower risk of losing money on the investment. This is because the stock has a higher value than what the investor paid for it, providing a cushion against any potential losses.
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  4. Catalysts for change: Many net-net companies are undervalued because they are facing some kind of problem or issue, such as declining sales or poor management. However, these companies may also have catalysts for change that can unlock value, such as a new product launch, management changes, or industry tailwinds. If these catalysts come to fruition, they can drive significant stock price appreciation.
  5. Neglected stocks: Net nets are often overlooked by the market and institutional investors, which can lead to mispricing and inefficiencies. However, as more investors discover and buy into these undervalued stocks, they can create a positive feedback loop that drives up the stock price.
  6. Small companies: Net-nets are oftentimes very small companies in terms of business and market cap. That gives individual investors a giant advantage: Institutional investors have a lot of money to manage and they cannot invest in most net-nets because of their size. Thus, net-net investing is uniquely limited to small investors who have an edge over large funds because they are nimble and can go walk off the beaten path.

Have net-nets ever been shown to underperform?

This is a common question by conservative investors. We get it. Nobody wants to lose money. And some people consider themselves unlucky. So have net-nets underperformed the market averages over the long term?

There is no specific long-term study that has shown net-nets to consistently underperform the market. In fact, the opposite is true. Historical data has every time shown that net-nets can be a profitable investment strategy over the long term. Underperformance, when it was observed in a study or backtest, has been short-lived and over the whole timeframe of a study, net-nets have outperformed every single time.

Considering that the concept of net-nets first appeared in the 1930s when it was popularized by the investor Benjamin Graham, it is remarkable that to this date, no long-term underperformance of net-nets has been shown in almost 100 years of financial data. Let that sink in!

This is why we have made this app, which is entirely dedicated to uncovering net-nets. We want to make net-net investing accessible to people by finding net-nets for you. We do use this website ourselves for our own net-net investing.

How many net-nets are there?

The number of net-nets in the stock market varries daily with market fluctuations. Net nets appear in abundance whenever volatility sweeps through a market. You can expect a great opportunity set when that happens. That said, there are always net-nets available somewhere in the world. Like Peter Cundill says: "There's always something to do". We're collecting stats on the available net-nets in the markets we cover over here.

Citations and further reading

The Net Current Asset Value Approach to Stock Investing: A Guide to Purchasing Stocks Trading Below Liquidation Value victor
An excellent introduction to net net investing by Victor J. Wendl, 2013, available on amazon
How the small investor can beat the market
Joel M. Greenblatt, Richard Pzena and Bruce L. Newberg published in the Journal of Portfolio Management, available here
Ben Graham’s Net Current Asset Values: A Performance Update
Henry R. Oppenheimer Financial Analysts Journal
Testing Benjamin Graham’s net current asset value model
a test of Net Net performance on quite recent data from January 2, 1999 to August 31, 2012, available here.
Testing the Performance of Graham’s Net Current Asset Value Strategy in Indian Stock Market
an example for international net net performance, available here