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FINANCIAL CHRONICLE™ » CHRONICLE™ ANALYTICS » Net Net Working Capital: Value Investing

Net Net Working Capital: Value Investing

+3
K.Haputantri
opfdo
sriranga
7 posters

Go down  Message [Page 1 of 1]

1Net Net Working Capital: Value Investing Empty Net Net Working Capital: Value Investing Sat Sep 22, 2012 1:10 pm

sriranga

sriranga
Co-Admin

What is Net Net Working Capital?

Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50% – Total Liabilities

“Net Net Working Capital” (NNWC) is one of the first stock valuation screening methods to be defined in the value investing world.  Benjamin Graham also referred to this as Net-Current-Asset Value (NCAV).

The Net Net Working Capital formula may help identify undervalued stocks.  Benjamin Graham actually used the term “Net Working Capital” but current value investors and Graham followers use the terms “net nets” or “Net Net Working Capital” interchangeably.

One value investing strategy of Graham was to purchase stocks that were trading at less than two-thirds of the Net-Current-Asset Value per Share (i.e. less than two-thirds of the Net Net Working Capital Value per Share).  This type of value investing strategy could be thought of as a “liquidation value investing strategy”.  In other words, Graham is proposing that the stock is so cheap that even under a situation where the business was wound down, that the investor would have a such a suitable margin of safety that a return could still be earned.  Of course, Graham is not counting on a liquidation since there are costs associated with that action.  Rather, Graham is satisfied that he is paying nothing for the fixed assets of the business nor is he paying anything for any potential earnings.

According to Graham, “The type of bargain issue that can be most readily identified is a common stock that sells for less than the company’s net working capital alone, after deducting all prior obligations.* This would mean that the buyer would pay nothing at all for the fixed assets—buildings, machinery, etc., or any good-will items that might exist.  Very few companies turn out to have an ultimate value less than the working capital alone, although scattered instances may be found.”  (Source:  The Intelligent Investor by Benjamin Graham).

Of course, stocks that are trading below their NNWC may be trading at such low multiples for various reasons (e.g. pending bankruptcy, misstated financial statements, or a host of reasons why investors may be shunning a particular stock).  Regardless, we present the Net Net Working Capital formula and provide further discussion.

Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50% – Total Liabilities

Once the NNWC is determined, this amount divided by the number of shares outstanding will provide the NNWC per share.  NNWC per share that is less than the current share price may be an indication of an undervalued stock or a deep value stock.  Graham advocated buying a basket of stocks whose prices traded significantly below NNWC per share (or Net Current Asset Value per Share – NCAV per Share).

The NNWC formula considers that not all balance sheet amounts may reflect current reality.  A 25% discount is applied to accounts receivable as these amounts may not actually be collectible.  In addition, a 50% discount to inventory is applied given that it may be stale or obsolete.  Of course, this is a first screen and potential investors should consider whether further discounts would be prudent.

The estimation or calculation of intrinsic value is as much art as science.  Any investor can run a mathematical screen to identify stocks trading at various metrics that could indicate potential value.  However, it must take keen business sense and deep curiosity to ask why a stock may be trading at the level it is, whether there actually is business value and how much, and what potential catalysts could emerge to unlock value.  The Net Net Working Capital formula is one more value investing tool.

Net Net Working Capital Formula – Further Analysis and Discussion:

Net Net Working Capital is a subset of Graham’s Net Working Capital is a subset of Net Working Capital (also known as Working Capital).

1) Net Working Capital = Current AssetsCurrent Liabilities

2) Graham’s Net Working Capital = Current AssetsTotal Liabilities

3) Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50%Total Liabilities


Note that the results of each formula are presented in a decreasing order.  That is to say Net Net Working Capital will provide the lowest and hence, most conservative, value.  In other words, all else being equal, of the three formulas above, a stock trading below Net Net Working Capital provides the investor with the largest margin of safety.

Edited article from http://deepvalueinvestor.com/

http://sharemarket-srilanka.blogspot.co.uk/

opfdo

opfdo
Vice President - Equity Analytics
Vice President - Equity Analytics

thank you. it is very interesting.

K.Haputantri

K.Haputantri
Co-Admin

Thanks Shri. Interesting article. Such shares are hard to find except in a bear market.

The Alchemist


Senior Manager - Equity Analytics
Senior Manager - Equity Analytics

Quote
One value investing strategy of Graham was to purchase stocks that were trading at less than two-thirds of the Net-Current-Asset Value per Share (i.e. less than two-thirds of the Net Net Working Capital Value per Share).
Unquote
One Share that comes to mind that fits the bill is RENU ! Trading at Rs 260, its Net Net Working Capital per share is around 375-390.
Other shares that trade at or less than two-thirds of NAV are CINV, GUAR, CIT, CFI

Slstock

Slstock
Director - Equity Analytics
Director - Equity Analytics

When we are talking about hidden net assets, maybe it is worthwhile looking at COCO/RHL with RAL at market prices. I am sure COCO net asset is much higher if we take RAL at curent market prices and then RHL inturn.






The Alchemist wrote:Quote
One value investing strategy of Graham was to purchase stocks that were trading at less than two-thirds of the Net-Current-Asset Value per Share (i.e. less than two-thirds of the Net Net Working Capital Value per Share).
Unquote
One Share that comes to mind that fits the bill is RENU ! Trading at Rs 260, its Net Net Working Capital per share is around 375-390.
Other shares that trade at or less than two-thirds of NAV are CINV, GUAR, CIT, CFI

malanp


Senior Manager - Equity Analytics
Senior Manager - Equity Analytics


the balance sheet should be equally represented by fixed assets and current assets if you count on this formula

if bulk of balance sheet comprise of current assets then this formula will give false positive signal. Being investment trusts CINV, GUAR,CIT,CFI fall into this category.

then

stocks that are trading below their NNWC may be trading at such low multiples for various reasons , misstated financial statements, lack of trust in director boards ,or many other reasons that investors dont want to buy this partiular share.

jehovah

jehovah
Equity Analytic
Equity Analytic

lol!

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