Whatever your risk appetite may be, you want to get solid returns for your investment while minimizing potential losses. What’s great about net-net stocks is that if you do your homework, you can get a handsome ROI while having a solid buffer of protection against risks.
But more than that, net-nets are so cheap. It’s like buying dollars for pennies, making net investing appealing to intelligent investors.
Why are net-net stocks so cheap?
One of the chief reasons you should consider investing in net-nets is that they are inexpensive and offer great returns. But why are net-net stocks so cheap?
Typically, companies with market caps below their Net Current Asset Value or NCAV face various issues. These issues often seem insurmountable and can severely undermine the performance of these businesses.
These companies’ revenue has taken a huge hit in the face of the issues they face, leaving investors in a hurry to cut their losses and leave.
That reaction is fairly natural. After all, why would someone prefer to hold out and wait for things to wait for the problems to subside and take a turn for the better? This is particularly true if a company has been racking up its debts.
There are cases where a company is distressed but has ample current assets and few liabilities.
This is the type of company net-net investors should try to find and invest in. But why, exactly?
Net investing in a troubled firm may seem counterintuitive, but if you follow Ben Graham’s strategy for investing in net-nets, you have to focus on a company’s current assets and not its revenues.
While some underperforming companies are still backed by current assets, focus on them if investing in net stocks.
4 ways to profit from net-nets
Ben Graham, considered the father of deep value investing, advocated choosing companies that generate positive income and pay dividends to their investors before succumbing to problems.
However, many net-net investors believe that positive income is not as important in net investing. Furthermore, paying dividends to investors can undermine the returns for net-net investors.
So how exactly can you profit from net stocks?
Liquidation
If a company is deeply troubled and unable to continue operating, liquidation can benefit net-net stock investors.
Due to its low net stock price, liquidating a company’s assets results in a significant cash windfall.
After liquidating the current assets, the company will then distribute the earnings from the sale to its shareholders after paying its debts.
If the company chooses partial liquidation, proceeds from selling an underperforming division would go to investors after paying off liabilities.
Third-party buyout
It should be noted that liquidation is not common among troubled companies. When a company has low net current assets, a larger company is more likely to acquire it.
This typically happens if the troubled company has brand recognition, a solid market position, or an appealing real estate property.
Price spikes
The price of net-net stocks can skyrocket well beyond the net current asset value after a company receives good news.
Because of a company’s troubles, most investors tend to shy away from it. But for example, if that company recovers and the news spreads fast, the same investors that have ignored it initially will look at it again and rush in to buy stocks.
This drives the stock prices up.
One great thing about net stocks is that their prices can take a steep upward trajectory in a short amount of time due to the combination of their low cost and the bad news surrounding a company.
It is not unusual for net-net stocks to increase their value by up to 100 percent.
Company recovery
Net-net stock prices can also soar when a company makes a miraculous recovery.
And it doesn’t take much recovery for net-net stocks to skyrocket. Because these companies are in such a bad place, a slight improvement in operations can trigger an uptick in net-net stock price.
Investing in net stock: weighing the pros and cons
Net-nets can certainly be appealing, especially if you are willing to put in the work. It certainly helps that the price of net-net stocks are often ridiculously low that the potential risks can be downplayed.
Why invest in net stocks?
One of the chief reasons why you should strongly consider investing in net stocks is the price.
But apart from that, there are also other benefits well worth considering. For starters, you do not have to worry about competition and efficient markets. Simply put, due to the reputation of companies with net-net stocks, there is a fairly small number of investors keen on putting their capital behind these businesses.
Another benefit of investing in net stocks is the ease of calculating value. To get a company’s net current asset value, all you have to do is subtract its total liabilities from its current assets.
To compute share value or net current asset value per share, divide the net current asset value by the shares outstanding.
Finally, if you are planning on investing in net-net stocks, you will get a substantial amount of risk protection from the company’s liquid assets.
Disadvantages of investing in net stocks
Despite the advantages offered by investing in net-nets, there are a few downsides that you need to be aware of.
For starters, your typical investor shies away from net-nets because troubled companies rarely inspire confidence.
If you are thinking of investing in net-nets, it is critical to perform due diligence. As much as possible, avoid companies that have lost a substantial customer base. Do not invest in companies that have a history of fraud and embezzlement. Stay away from companies that offer products that are unlikely to get governmental approval for their products.
Net stocks: fortune favors the bold
Net investing can offer great yields if you are willing to do your homework and check the company’s background you are planning to invest in.
Remember, net-nets have a low market price for a reason: the companies behind these are in pretty bad shape. But if you follow the net investing tips laid out above, there is no reason why you should not be rewarded handsomely for the work that you put in. If you are keen on trying net investing, remember that a company’s current assets should draw your attention and not the stock price.
