Net Net Working Capital (NNWC) by Benjamin Graham

Net Net Working Capital (NNWC) by Benjamin Graham

•  NCAV = Current Asset - Total Liabilities- Preferred Stock
  

• Current Asset are already cash or convertible into cash within a relatively short period of time.
  

• Stock price sold higher than book value was driven by a company’s earning power and dividend payments.
  

• Stock price is less than the per NCAV were primally driven down by poor earnings.
  

• Graham isn’t interested in the total assets of a company. He is only interested in the most liquid assets on the balance sheet. 
  

• “To be as concrete as possible, let us suggest that an issue is not a true ‘bargain’ unless the indicated value is at least 50 percent more than the price.”
  

• “…if a common stock can be bought at no more than two-thirds of the working-capital alone—disregarding all other assets—and if the earnings record and prospects are reasonably satisfactory, there is strong reason to believe that the investor is getting substantially more than his money’s worth.” 
  

 
Net Net Working Capital (NNWC) by Benjamin Graham

• The lowest form of valuation - ignores everything & just focuses on tangible assets.
  

• NNWC = Cash and short-term investments + (0.75 x accounts receivable) + (0.5 x inventory)
  - total liabilities
  

• Investor have to weeding out the bad one and look for a business that is stable so that operating losses don’t eat away the existing cash and other components of Net Net Working Capital. 
  

• Is Net Net valuation infallible?
  

•  AR in Construction - can very well vanish into the thin air, or turned to be payable. (dispute, abbitration, court case)
  

• Inventories in Fashion or Technology - it can end up worthless
  

• Cash - may end up in other people pockets or burned away due to improper allocation of resources / poor business with persistent loss
  

• We can look for net net company with following attributes:-
  

• Company Share Buy Back
  

• Insider Buying
  

• A consumer brand name
  

• An easy to understand business 
  

• Activist investor or management creating a catalyst
  

• From 2000 to 2012, NNWC stock achive 18.28% CAGR of returns.
  

 
Negative Enterprise Value

• Enterprise Value = Market Capitalization + Total Debt - Excess Cash 
  

• Excess Cash = Total Cash - MAX(0,Current Liabilities-Current Assets)
  

• If the excess cash in cash and marketable securities exceed the cumulated market values of debt and equity, it gives you a negative enterprise value.
  

• An easy arbitrage opportunity, where you can buy all of the debt and equity in a firm and use its cash balance to cover your investment costs and keep the difference (in theory......)
  

 
Risk & Mitigation Plan

• Business trade under NNWC facing some serious pressure and trouble (business sucks) and that threaten to put them in bankruptcy -- that's why business operations are completly ignored.
  

• There is a lot of volatility and you need to buy micro or small caps - it is not for faint hearted.
  

• Two possibles reasons why Net Net may fail:-
  

• Changing intrinsic value - based on development of business e.g. loss money & reduce it working capital
  

• Market behaviour - stock price not necessary follow to the value that analyst place on it.
  

• Filter net net based on following criteria
  

• “Reasonably satisfactory” earnings record and prospects: Companies that are losing money or have an erratic earnings history are likely to see their intrinsic value decline, making them less undervalued or potentially overvalued.
  

•  “Sound financial condition”: As a test for financial strength, Graham suggests looking for companies with total stockholder’s equity (common and preferred equity) greater than the total of current liabilities and long-term debt.
  

• Positive operating cash flow for T4Q: To prevent companies liquidate assets to meet its obligations
  

• Prevent Perennial net nets: companies that are stuck trading below their NCAV. 
  

• “…stocks selling below working capital and showing a fair record of earnings and dividends are likely to be ‘bargain’ issues and are likely to turn out to be unusually satisfactory purchases.” [Graham used the terms working capital and net current assets interchangeably.] To offset the potential of investing in individual stocks that turn out to be unprofitable, Graham suggested holding at least 30 stocks at a time.
  

 
When to sell a Net Net?

• Bought  at 67% of its NCAV and hold it until he had a 50% gain, or
  
• He had held it for two years.