Hot markets, cold markets and everything in between.
Net-nets will continue to exist.
The quality of net-nets changes depending on the market temperature, but they are there – like hobbits hiding in the roots of trees.
One way to gauge market sentiment is by leveraging the number of net-nets existing at any one time.
A simple and very clear indicator of when a market is cheap and when it’s not.
Anything in between is a hit and miss.
Searching for net-nets at old school value
With our regular screener and data additions, net-net data is now available for you to screen.
You can screen for NCAV and NNWC.
First, take a cool refresher.
- NCAV = Net Current Asset Value = Total Current Assets – Total Liabilities.
- NNWC = Net-Net Working Capital = Cash and Equivalents + (Accounts Receivables x 0.75) + (Inventory x 0.5) – Total Liabilities.
Because I don’t want to fill up your screener sidebar with too many preset screens, I haven’t created any default net-net screens.
NCAV stock screen
Here’s how my NCAV stock screen is set up.
The goal here is to keep it simple and cast a wide net.
I’m looking for stocks where the NCAV is greater than the market cap. I’ve added an extra criteria of wanting stocks where the three-year growth of NCAV is positive.
It is a quick way to eliminate stocks where the value is being wiped out.
Before I get to the results, I also set up my results report by creating a custom report for the data I want relevant to net-nets. I don’t need stats like CROIC, margins or other metrics used for common value stocks.
Here’s what I have saved in my account.
Focused NCAV custom report
NCAV screen results
You can save more time by adding additional filters to remove Chinese stocks and certain industries/sectors.
Or keep it simple as I did and you’ll get results like the following which you can filter down further manually.
If you do want to eliminate Chinese companies, add “registered country” and choose “is not” China.
- NCAV of $100 million.
- Market cap of $5.95 million.
- P/NCAV of 0.06.
It is either mind-blowingly cheap – or too good to be true.
Based on my experience, I’ll take the latter.
After having lost a big chunk of money several years back on Chinese stocks, I’m OK with letting my mental biases dislike Chinese net-nets.
Let’s see what else is swimming at the bottom of the barrel.
Sears Hometown and Outlet Stores
The chart above is a Price vs. DCF fair value chart where, in hindsight, the company continued to erode intrinsic value to meet the current “value.” It went from a spinoff all the way down to its current net-net status.
I won’t get into the full history of Sears Hometown and Outlet Stores because when it comes to net-nets, I like to get to the point.
Net-nets are not complex investments. They are not sexy – one of the reasons why they are overlooked so often.
This one happened to grab my attention because I have yet to come across any net-net spinoffs.
Let’s quickly revisit the net-net checklist.
- Stay within circle of competence.
- No Chinese stocks.
- Has a valid operating business.
- Low cash burn.
- No debt or very easily manageable.
- No insider selling.
- Signs of buybacks.
This is a basic checklist only. There will be other factors that you’ll want to add, but these seven checks will eliminate most net-nets quickly.
Stay within circle of competence
It is a retailer of appliances, lawn and garden equipment and other home goods. The products are easy to understand, but the industry is gut wrenching.
In terms of getting your head around what it does, it’s easy.
When it comes to really understanding how the industry operates and what it takes to succeed, that’s another question.
But let’s check it off as a pass for now.
No Chinese stocks
U.S. company. Easy one.
Has a valid operating business
Yes the business is valid. It is not a pre-revenue company or a cash box.
Whether its business is still valid is another question. Its net-net status can be telling that it’s now an invalid model.
Low cash burn
Open up the balance sheet and look up the quarter-over-quarter differences in cash.
I’m going to cheat here with OSV Online.
To do this on your own:
- Go to Google Finance or any other site with at least five quarters of balance sheet data. Eight to 10 quarters is better.
- Copy or export the cash and equivalents data and calculate the year-over-year and quarter-over-quarter changes in cash.
I did it slightly differently by calculating the comparable period of the same quarter a year ago.
For Sears Hometown and Outlet Stores if I look at the quarter-over-quarter calculation, it is burning 7% of cash on average over the last five quarters. The five quarters before that, it was 2.9%.
With $14.1 million of cash and equivalents, there are about eight quarters left before operations are materially affected.
Two years isn’t long enough of a holding period for net-nets. You need at least three years for things to work out.
This one is a fail.
No debt or very easily manageable
Not looking good.
Most of the debt is short term. With cash required to run the business and finance short-term debt, things could get even uglier.
Debt is mostly short term.
No insider selling
Insiders are buying.
It’s a shame to see them losing so much money.
But, hey, this meets the criteria.
Signs of buybacks
No share buybacks, but the consolation is that shares are not being diluted to raise capital.
SHOS Shares Outstanding Chart
Sears Hometown and Outlet Stores as a net-net?
- Stay within circle of competence – pass.
- No Chinese stocks – pass.
- Has a valid operating business – pass.
- Low cash burn – fail.
- No debt or very easily manageable – fail.
- No insider selling – pass.
- Signs of buybacks – pass.
It doesn’t meet all seven, and two of the most important are No. 4 and No. 5.
Sears Hometown and Outlet Stores is cheap, but it’s a net-net for speculation only. Not one you want to put any significant amount into.
Try it yourself
Here are some other companies that came up in my list.
Try it yourself and see. Don’t expect much. More for practice.
- Ovascience (OVAS, Financial).
- Endocyte (ECYT, Financial).
- Entertainment GMGÂ (EGT, Financial).
- Atossa GeneticsÂ (ATOS, Financial).
- Manning and NapierÂ (MN, Financial).
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