What You’ll Learn
- What is a net net and what characteristics they hold.
- A short list of net net stocks in the US market.
- 3 basic checks to perform on net-nets to see whether it’s worth investing in.
With such a hot market, a section of the market that is clearly overlooked is the cheap Graham net net market.
Net Net stocks have the following characteristics:
- ugly stocks
- horrible businesses
- big glaring issues
- bad management team
- often penny stock prices
The term net net comes from Graham, when he first came up with Net Current Asset Value and Net Net Working Capital.
NCAV = Current Assets – Total Liabilities
You can see how cheap a stock is if the price is below NCAV per share.
It’s telling you that the company is basically worth nothing more than the tangible assets on the balance sheet.
But net net’s aren’t totally useless because these ugly stocks are certainly overlooked.
Nobody wants to be holding a piece of junk that you can’t show off to friends.
I maintain a list of net nets to look at once a while, but during this bull market, the list is definitely thin.
At the time of this writing, the list is:
- Armco Metals Holdings (AMCO)
- STR Holdings (STRI)
- Ocean Power Technologies (OPTT)
- Emerson Radio Corp (MSN)
- Delcath Systems (DCTH)
- Sears Hometown and Outlet Stores (SHOS)
- SGOCO Group (SGOC)
Well there is one net net that is worth looking at.
Emerson Radio .
Calculate NNWC (Net-Net Working Capital)
When I look at net-nets, I ALWAYS look at the balance sheet.
I first use the NNWC (Net-Net Working Capital) method which is the most conservative measure. It’s a modified version of the NCAV formula above.
NNWC = Cash + (0.75 x Accounts receivables) + (0.5 x Inventory) – Total Liabilities
Think of it as the price a company will be sold for in a fire sale.
Here is what I see for Emerson Radio using the Net Net section of the Old School Value Analyzer.
At first glance, it’s looking good so far. The stock is trading below the NCAV and NNWC per share vale.
That’s extremely cheap and it also acts as a big margin of safety too.
A healthy balance sheet is a number 1 requirement for a failing business.
Moving onto the next check.
Check FCF or Owner Earnings
Next, I want to make sure that the net-net stock is not burning cash. The longer a company can live through its “burn rate”, the better.
If you look at FCF, the up and down is evident over the past 5 years. But it does pass the test of not being negative year over year.
The TTM figures are as of Q3 so it looks like fiscal 2014 will be another positive year for FCF.
Check Basic Items from Income Statement
Here’s where you get to see the issues Emerson is experiencing.
Keep in mind that I’m not trying to go too deep into analyzing the financial statements. There’s no need to with net nets because the issues are so obvious and if you know your accounting, you should be able to know the numbers in less than 10 minutes.
Revenues have been slashed, and SG&A is increasing which is a red flag.
At the moment, operating income is still positive though. It’s nothing pretty to look at however.
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
- not be bleeding cash (at least breaking even or positive)
- have positive EBITDA
These are three very basic checks that will weed out many net-nets right away.
Revisiting some characteristics from up top, don’t expect much in terms of management effectiveness. Take a look at the following metrics.
The cash conversion cycle also tell a similar story.
The median time to convert inventory to cash was 26.2 days. But in the TTM, it’s ballooned to 66.9 days.
Obvious issue glaring at you.
Considering all the bad stocks that fall into the net net category, I’m surprised that Emerson isn’t as bad as it looks.
Management performance and the business itself is horrible, but with a slow cash burn rate, and healthy balance sheet with huge amounts of cash for its current state, Emerson isn’t one that I’d throw out just yet.
There’s definitely more work that needs to be done, and I haven’t gone into all the business troubles, but collect a basket of net nets like Emerson Radio and you’ll be much better off at retirement.
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