One Last Puff 🚬
Exploring the World of Cigar-Butt Stocks and Net-Net Investing
Investing in the stock market has long been a pathway to wealth for those who understand its intricacies & nuances. Among the myriad of strategies that investors use to identify undervalued stocks, cigar-butt investing and the net-net investing approach stand out for their simplicity and potential for high returns.
Cigar-Butt Stocks: A Brief Overview
The term "cigar-butt" investing was popularized by Warren Buffett, one of the most successful investors of all time. The concept is simple yet profound: investing in cigar-butt stocks is akin to picking up a discarded cigar-butt with a few puffs left. These are companies that are typically out of favor with the market, often trading at a significant discount to their intrinsic value. They may not be the prettiest or most popular stocks, but they offer one last "puff" — a chance for one last surge in price before they fade into obscurity.
What is Net-Net Investing?
Net-net investing is a strategy that focuses on buying companies whose stock prices are less than their net current asset value (NCAV). This approach was first introduced by Benjamin Graham, the father of value investing, in the 1930s. The formula to calculate NCAV is simple:
NCAV = Current Assets - Total Liabilities
The idea is that if a company is trading for less than its NCAV, it is undervalued. This is because, theoretically, if the company were liquidated, the assets could be sold off and after paying off all liabilities, there would still be money left over for shareholders.
Digging Deeper: NCAV and NNWC
Net Current Asset Value (NCAV) provides a rough estimate of the liquidation value of a company. However, investors seeking a more conservative figure might turn to Net-Net Working Capital (NNWC). NNWC adjusts NCAV by taking into account the quality and liquidity of a company's assets. The formula for NNWC is a bit more complex, factoring in only a portion of receivables and inventories, and subtracting all liabilities:
NNWC = Cash and Short-Term Investments + (0.75 × Accounts Receivable) + (0.5 × Inventory) - Total Liabilities
This calculation provides a "safer" net-net figure, considering that not all assets can be liquidated at their book values.
Share Dilution: A Critical Consideration
Share dilution occurs when a company issues additional shares, reducing the ownership percentage of existing shareholders. For net-net investors, dilution can be a significant risk because it can decrease the per-share value of NCAV and NNWC. Investors should be wary of companies with a history of diluting shares, as it can erode the potential gains from investing in undervalued stocks.
The Art of Net-Net Investing
Investing in net-net stocks requires patience, thorough research, and a contrarian mindset. Here are some key points to remember:
Selection Criteria: Look for companies trading below their NCAV or NNWC, but also consider the business's quality, its industry position, and the likelihood of a turnaround.
Margin of Safety: The discount to NCAV or NNWC provides a margin of safety, protecting investors from permanent capital loss.
Market Sentiment: Cigar-butt stocks are often ignored or undervalued due to negative market sentiment, providing opportunities for astute investors.
Diversification: Due to the inherent risks and uncertainties with these companies, diversifying across several net-net stocks can reduce the risk of significant losses.
Final Thoughts
Cigar-butt and net-net investing are not for everyone. They require a disciplined approach, a willingness to delve into financial statements, and the patience to wait for the market to recognize the company's true value. However, for those willing to do the homework, these strategies can uncover hidden gems and provide substantial returns. As always, investors should perform their due diligence and consider their risk tolerance before diving into the world of cigar-butt and net-net investing.
Preet Saini
CEO & Founder, Singh Stocks LLC
