Ben Graham popularized net-net investing, and this is one area of the market where I like to look for undervalued companies. Net-net investing means investing in companies that trade at a price that values them below the value of current assets. It is a very strict valuation rule because it means the company trades below the value of its cash and cash equivalents, accounts receivable (adjusted for doubtful accounts) and inventory (which you should adjust as well). The total of all liabilities is then deducted from current assets to arrive at a net-net value. Obviously it is a lot of work to go through this excercise with every company in the U.S. It is much easier to use GuruFocus' net-net screener, but make sure you read the criteria on which it relies.
Academic research shows that investing in net-nets can be incredibly lucrative and rewarding. This study spanning 1984 to 2008 found monthly returns of 2.55%.
Without further ado, here are the companies that currently score best on the Price/NCAV discount (find the full list here):
Verastem
Verastem (VSTM, Financial) is a biotech that develops drugs to combat cancer. It aims to do so through targeted killing of cancer stem cells. A cell like that is an especially aggressive type of tumor cell. It usually resists current cancer therapy. Below you’ll see its balance sheet, from the most recent 10-Q:
In addition, last year there was quite a bit of insider buying going on:
Gurus Jim Simons (Trades, Portfolio) and First Eagle Investment (Trades, Portfolio) have sold out, however. The big decline in stock price and selling out by gurus is most likely the result of the company ending its Phase 2 trial for its VS-6063 drug candidate. The company subsequently also let go of a number of employees. Its bleak future has brought it in net-net territory. It’s a common trait of net-nets to have bleak futures or a lot of hair on them.
KBS Fashion Group
KBS Fashion Group Limited (KBSF, Financial) calls itself a “leading fully integrated casual menswear company in China.”
"Leading" is kind of nonsense because it only has 114 stores in a country with 1 billion people. Its website looks good, but I am somewhat apprehensive to invest in China-domiciled companies like this one. The problem I face here is that I can’t trust the statements provided. Occasionally I deem the opportunity great enough to offset the risk of having one pulled on me, but I am very careful in this part of the world. If you can independently verify whether assets are present, that is a real improvement over just relying on the filings. I couldn’t fault anyone for not including this one with a basket of net-nets. Below its latest balance sheet as filed with the SEC:
Avalanche Biotechnologies
Avalanche Biotechnologies (AAVL, Financial) is a biotech focused on discovering and developing gene therapy to help patients with ophthalmic diseases. Its main product candidate is AVA-101 to treat wet age-related macular degeneration (AMD). It is trading at a 50% discount to its net cash, and it is being snapped up by a number of gurus including PRIMECAP Management and Chuck Royce (Trades, Portfolio). Paul Tudor Jones (Trades, Portfolio) moved away from the company. On an EV/EBIT base it trades at 3.48x.
Gravity Co.
Gravity Co. (GRVY, Financial) is a game developer and publisher in Japan and Thailand (but based in Korea). The company has a small portfolio of games, but its most important one is Ragnarok Online. This product is in decline, and the company will soon try to refresh its user base with an update. The company trades at roughly 60% of its net cash. It trades at an EV/EBIT of roughly 2x and a forward P/E of roughly 8x.
Tikcro Technologies
Tikcro Technologies (TIKRF, Financial) has an investment in BioCancell Therapeutics Inc. (XTAE:BICL, Financial) through which the company is engaged in the discovery, development and commercialization of therapies to treat solid cancer tumors. It trades at roughly 50% of net cash and at an EV/EBIT ratio of 5.51x. There is no doubt the company has been something of a value trap over the past decade:
GuruFocus already reported on Steven N. Bronson taking action against the incumbent management in 2007, and he appears to have made some headway as a different CEO has been installed in the meantime. Bronson continues to hold approximately 16% of shares.
Disclosure: Long Gravity
