Graham’s Net-Net Strategy: Extreme Value

Difficulty: Advanced Tags: benjamin-graham, net-net, deep-value, advanced

Introduction

Imagine you’re at a garage sale, and you stumble upon a brand new, still-in-the-box video game console for a fraction of its original price. You know it’s a steal, and you can’t wait to take it home and start playing. Now, imagine applying this same mindset to the stock market. Benjamin Graham, the father of value investing, developed a strategy that helps investors find undervalued companies at bargain prices. This strategy is called the Net-Net strategy, and it’s a powerful tool for extreme value investing.

What Is It?

Graham’s Net-Net strategy involves buying companies at a price significantly lower than their net current assets (NCA) per share. NCA is calculated by subtracting a company’s total liabilities from its total current assets. The idea is that if a company’s stock price is lower than its NCA, it’s likely undervalued and could be a good investment opportunity.

Why Should Teens Care?

As a teenager, you might not be thinking about investing just yet, but it’s essential to understand the basics of value investing. The Net-Net strategy can help you develop a long-term perspective and a disciplined approach to investing. By learning about this strategy, you’ll gain a deeper understanding of the stock market and how to make informed investment decisions.

Key Concepts

To understand the Net-Net strategy, you need to grasp the following key concepts:

Net Current Assets (NCA): A company’s total current assets minus its total liabilities.
Net-Net Working Capital: A company’s NCA minus its total debt.
Margin of Safety: The difference between a company’s stock price and its NCA. A higher margin of safety indicates a lower risk investment.
Graham’s Formula: A formula used to estimate a company’s intrinsic value based on its NCA and earnings.

Let’s break it down with an example:

Suppose you’re analyzing a company called XYZ Inc. Its total current assets are $100 million, and its total liabilities are $50 million. The NCA would be $50 million ($100 million - $50 million). If the company has 10 million shares outstanding, the NCA per share would be $5 ($50 million ÷ 10 million shares). If the stock price is $3, the margin of safety would be $2 ($5 - $3).

Real-World Examples

In the 1970s, Benjamin Graham applied the Net-Net strategy to his investment portfolio. One of his notable investments was in a company called GEICO, which was trading at a significant discount to its NCA. Graham’s investment in GEICO generated impressive returns, and it’s a classic example of the Net-Net strategy in action.

Another example is the investment firm, Third Avenue Management, which has successfully applied the Net-Net strategy to its investment portfolio. The firm’s founder, Martin Whitman, is a well-known value investor who has written extensively on the topic.

Try It Yourself

Let’s practice applying the Net-Net strategy to a real-world example. Choose a company you’re interested in, and follow these steps:

Find the company’s latest financial statements (10-K or 10-Q).
Calculate the company’s NCA by subtracting its total liabilities from its total current assets.
Calculate the NCA per share by dividing the NCA by the number of shares outstanding.
Compare the NCA per share to the current stock price.
If the stock price is lower than the NCA per share, it might be a potential investment opportunity.

Key Takeaways

The Net-Net strategy involves buying companies at a price significantly lower than their NCA per share.
A higher margin of safety indicates a lower risk investment.
Graham’s Formula can be used to estimate a company’s intrinsic value.
The Net-Net strategy requires a disciplined approach and a long-term perspective.

Disclaimer

This article is for educational purposes only and should not be considered as investment advice. Investing involves risk, and it’s essential to do your own research and consult with a financial advisor before making any investment decisions.

By understanding the Net-Net strategy, you’ll gain a deeper appreciation for value investing and the importance of a disciplined approach. Remember, investing is a long-term game, and it’s essential to be patient and informed.

Graham's Net-Net Strategy: Extreme Value