How to Quickly Value Net Net Stocks

November 14, 2012 | Comments (3)

Written by

Jae Jun

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Back in the first quarter of 2009, I bought a net net by the name of iGo inc.

The company sells chargers for laptops and mobile devices as well as accessories such as earphones. I bought them back in 2009 at a price of around $0.50 and I recently noticed the company getting hammered and down to $0.25 which is even further down from when I first purchased.

But here is why I wouldn’t even think of buying it this time around.

First the quick basics.

Calculate NNWC (Net Net Working Capital)

When I look at net nets, I immediately look at the balance sheet.

I first use the NNWC (Net Net Working Capital) method which is the most conservative measure. It is likely the price a company will be sold for in a fire sale.

Using the OSV intrinsic value spreadsheet and entering the balance sheet numbers from the latest third quarter Nov 8 filing, IGOI’s NNWC surprisingly comes out to $0.42 per share.

If this is your first time looking at iGo inc, you may be interested and tempted to buy. But this is just an early check.

Check FCF or Owner Earnings

Next I want to make sure that the net net stock is not burning cash.

Head over to the financial statements to perform a quick check of its free cash flow.

When I bought in 2009, I only have 2007 and 2008 to work with and both were positive years in terms of FCF with improving owner earnings and offered a better future outlook.

However, the story is drastically different now. FCF has fallen off a cliff and owner earnings is accelerating downwards. What makes this a clear danger signal is that capital expenditure has remained somewhere around the average. This means that the losses are occurring from either

  • drop in revenues
  • or increase in expenses

Check Basic Items from Income Statement

Looking at the income statement, iGo inc shows both.

Revenue is less than half of what it was in 2008 while cost of revenue has not dropped as quickly. SG&A is extremely high and the increase in R&D with the income statement in this state only signals that the company is trying to pursue some new products or agenda which has not led to any results.

At this point, it is a no brainer to move on, but just for the sake of this exercise, let’s look at some additional checks you can do.

3 Basic Checks to Perform for a Net Net

For a net net to be investable, it should have

  • a solid balance sheet, preferably more cash than inventory or receivables.
  • is not bleeding cash. At least breaking even or positive.
  • positive EBITDA

These are three very basic checks that will weed out many net nets right away.

As with all net net’s don’t expect much in terms of management effectiveness. Take a look at the following metrics.

The cash conversion cycle tells the same story.

It takes iGo inc 123 days to convert its inventory to cash.

Future Business Hopes?

iGo inc is banking its hopes in a collaborative development of an integrated circuit based on iGO Green with Texas Instruments.

This has been ongoing for  a while with nothing to show for it. Although the earliest expected production date is in the second quarter of 2013, the product must be a mega hit for the fortunes of iGo to turn around.

Even if it is successful, that would mean that the majority of its revenues would then come from a single product which is a commodity. Another big risk to consider.

Disclosure

None

  • Trebek

    I am not familiar with this company Jae, but I like your analysis. The question always is does a cigar butt have one good puff left in it or should you pass and just stomp on it? I think you have wisely chosen the latter. I am usually wary of Net Nets in the tech or retail space. To puff or not to puff is the Net Net investors dilemma.

  • http://www.oldschoolvalue.com/ Old School Value

    Yes and that last puff is the most difficult to analyze. I’ve found myself in a few positions trying to puff, but all that was really left was just the cigar butt.

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