Net-Net Working Capital
Benjamin Graham famously recommended looking at stocks that trade below their net-net working capital (NNWC) value per share (current assets – all liabilities). A lot of modern value investors have talked about this metric as a classic example of buying stocks with a large margin of safety, but also as a dated technique for the simple reason that few securities in recent history have met this criteria.
However, with the precipitous decline of stock markets at the end of 2008 many of these opportunities have reemerged, and it is worth taking a look at this strategy.
The basic premise is that net-net working capital should be a conservative estimate of liquidation value, because it ascribes zero value to fixed assets, while giving full value to all liabilities (on the balance sheet).
There are a few things to watch out for:
1) NNWC of a rapidly deteriorating business can quickly fall so that the stock price may not be bargain – this problem is compounded the more time elapses between the reporting date for the balance sheet and the date you are looking at the share price.
2) The company could have significant off-balance sheet liabilities such as contingent liabilities, underfunded pension plans, or pending legal settlements.
3) The book value of the current assets could overstate the true value of the assets. For example, current assets could include obsolete inventory or doubtful accounts receivable that haven’t been written down to fair values.
4) Everything from outright fraud to specific situations such as the stock is trading ex-dividend.
That being said, I still like NNWC because you can run some relatively easy screens and find a pool of interesting securities worthy of investigating further. The table below is the result of a screen I performed on the Yahoo Finance stock screener on July 17, 2009. I don’t remember the exact screen criteria, but I started with a combination of a low P/B, high cash per share, and then went through balance sheet data on a stock by stock basis to calculate NNWC/share.
A couple of quick notes on this:
1) In addition to NNWC I have calculated Net Cash Per Share (cash & equiv – total liabilities per share), an even more conservative measure of liquidation value.
2) I have calculated the “ROI back to NNWC” and the “ROI back to Net Cash.” The percentage itself isn’t meant to be any indication of the return likely on that investment, but rather a way to measure how far below these valuation estimates the stock is trading. Remember, no one is claiming that NNWC or Net Cash per share is the FAIR value, just that it is likely to be a conservative estimate of value.
I will be coming back to this table in a few posts to look at some of the more interesting stocks in more detail.