Net net investing refers to a value investing strategy of buying stocks trading significantly below their net current asset value. This deep value approach was pioneered by Benjamin Graham and David Dodd, and further popularized by Warren Buffett. The key idea is to buy stocks where market capitalization is lower than net current assets, essentially getting the business for free. Net nets provide a significant margin of safety, though lack of liquidity and potential issues with financial reporting need to be considered. When executed properly, net net investing can generate exceptional returns over the long run. This article will provide an in-depth look at the net net strategy, including how to screen for net nets, assessing quality, and portfolio construction.
How to identify net net stocks with strong balance sheets
The first step in net net investing is identifying stocks that meet the criteria of trading below net current assets. Screeners can be used to filter on market cap below net current assets. It’s also important to review financial statements and dig into details like cash, inventories, and receivables. Quality of assets and liabilities should be scrutinized. Strong net nets will have cash and short-term investments, with minimal intangible assets or goodwill. Look for upward trends in book value. Avoid net nets with excessive liabilities or reliance on inventory. The best net nets feature strong balance sheets with quality current assets.
Assessing management and business viability of net net stocks
In addition to balance sheet strength, the underlying business and management team should be evaluated. Look for competent, shareholder-oriented management with a reasonable strategy for generating profits and deploying capital. Analyze business prospects and competitive position. Ideally, the company will have a moat, pricing power, or turnaround potential. Be wary of excessive executive compensation, frequent leadership changes, or accounting manipulations. The goal is to find net nets with the operational capability to realize their deep value over time. Patient holding periods are required for business improvements to materialize.
Constructing a diversified portfolio of net net stocks
A net net portfolio should be diversified across at least 10-15 stocks from different sectors. This mitigates individual business risk. Position sizing of 1-5% is recommended based on conviction level and liquidity constraints. Rebalancing into outperformers while selling at fair valuation is key. The portfolio should be constantly monitored, with financial statements reviewed regularly. Upside potential of 3-5x over 2-3 years is reasonable for net nets. Patience is critical, as it may take time for Mr. Market to recognize intrinsic value. Loss-making positions should be quickly sold. Net net investing requires discipline, but can generate exceptional long-term returns.
Net net investing represents a proven value strategy with potential for significant upside. With diligent security analysis and portfolio construction, net nets can provide asymmetric returns for long-term compounding.