Net Net Working Capital (Value Investing)

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 Assets – Current Liabilities

2) Graham’s Net Working Capital = Current Assets – Total 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.

Value investing is about buying a stock at a sufficient discount to intrinsic value.  Graham’s “Net Working Capital” or the “Net Net Working Capital” formulas can be used as preliminary screens to identify potentially undervalued stocks or deep value stocks.

http://deepvalueinvestor.com/net-net-working-capital/

Benjamin Graham: The Father of Screening

Many value investors claim to trace their antecedents to Ben Graham and to use the book on security analysis that he co-authored with David Dodd in 1934 as their investment bible. But who was Ben Graham, and what were his views on investing? Did he invent screening, and do his screens still work?

Graham’s Screens 

Ben Graham started life as a financial analyst and later was part of an investment partnership on Wall Street. While he was successful on both counts, his reputation was made in the classroom. He taught at Columbia and the New York Institute of Finance for more than three decades and during that period developed a loyal following among his students. In fact, much of Mr. Graham’s fame comes from the success enjoyed by his students in the market.

It was in the first edition of Security Analysis that Ben Graham put his mind to converting his views on markets to specific screens that could be used to find undervalued stocks. While the numbers in the screens did change slightly from edition to edition, they preserved their original form and are as follows:

1. Earnings to price ratio that is double the AAA bond yield
2. PE of the stock has to be less than 40 percent of the average PE for all stocks over the past five years
3. Dividend Yield > Two-thirds of the AAA Corporate Bond Yield
4. Price < Two-thirds of Tangible Book Value1
5. Price < Two-thirds of  Net Current Asset Value (NCAV), where net current asset value is defined as liquid current assets including cash minus current liabilities
6. Debt-Equity Ratio (Book Value) has to be less than one
7. Current Assets > Twice Current Liabilities
8. Debt < Twice Net Current Assets
9. Historical Growth in EPS (over last 10 years) > 7%
10. No more than two years of declining earnings over the previous 10 years


Tangible book value is computed by subtracting the value of intangible assets, such as goodwill, from the total book value.


Any stock that passes all 10 screens, Graham argued, would make a worthwhile investment. It is worth noting that while there have been a number of screens that have been developed by practitioners since these first appeared, many of them are derived from or are subsets of these original screens.

The Performance 

How well do Ben Graham’s screens work when it comes to picking stocks? 

• Henry Oppenheimer studied the portfolios obtained from these screens from 1974 to 1981 and concluded that you could have made an annual return well in excess of the market. 
• As we will see later in this section, academics have tested individual screens—low PE ratios and high dividend yields to name two—in recent years and have found that they indeed yield portfolios that deliver higher returns. 
• Mark Hulbert, who evaluates the performance of investment newsletters, found newsletters that espoused to follow Graham did much better than other newsletters.

http://media.wiley.com/product_data/excerpt/32/04713450/0471345032.pdf

Value Investing - Benjamin Graham's Formula

Benjamin Graham's Formula   


In The Intelligent Investor, Benjamin Graham describes a formula he used to value stocks. He disregarded complicated calculations and kept his formula simple. In his words: 

"Our study of the various methods has led us to suggest a foreshortened and quite simple formula for the evaluation of growth stocks, which is intended to produce figures fairly close to those resulting from the more refined mathematical calculations."

His formula is as follows:

Intrinsic Value = EPS * (8.5 + 2* G)

EPS = Earnings per Share, G = Long Term EPS Growth Rate

This formula has little practical value to most value investors. A company with an expected growth rate of 10% in EPS could have a P/E (Price/Earnings) of 28.5 to be considered a buy. Most value investors would reject it. However, Graham also preached Margin of Safety. Therefore, taking this formula and allowing a 50% Margin of Safety you arrive at a P/E of 14.25 . Many value investors would take a hard look at a company with a 14.5 P/E growing earnings at 10% a year.

The formula is efficient and simplistic but has its limits:  the model doesn’t work for every stock. It should never be used in isolation. The investor must take into account many other factors such as current asset value, debt to equity ratio etc. 

http://www.trade4rich.com/Benjamin.html

Comment: Warren Buffett thought Benjamin Graham was not at his best when he came up with the various formulae to value stocks.

Graham Intrinsic Value video tutorial

Using the Stock Research Pro Software to Calculate Intrsinsic Value Using the Benjamin Graham Formula

Stock Research Pro is a desktop software application designed to guide and streamline the stock research, analysis, and valuation process. The software includes an automated calculator to arrive at a stock’s intrinsic value using the Benjamin Graham formula.

Click here to launch the Graham intrinsic value video tutorial.

http://stockresearchpro.com/graham2

http://www.stockresearchpro.com/benjamin-graham-intrinsic-value-calculator

Benjamin Graham Formula Valuation Spreadsheet

Benjamin Graham Spreadsheet Screenshot

Click here to download the above to analyse your stocks. 
http://sites.google.com/site/jjun0366/OSV_Graham_Formula_Spreadsheet-Basic.xls?attredirects=0


Also visit:
http://www.oldschoolvalue.com/intrinsic-value-spreadsheets/

http://www.oldschoolvalue.com/investment-tools/benjamin-graham-formula-valuation-spreadsheet/

• You can also download the other FREE and best investment valuation spreadsheet.

How To Value A Stock With Benjamin Graham’s Formula

How To Value A Stock With Benjamin Graham’s Formula


http://www.oldschoolvalue.com/investment-tools/benjamin-graham-formula-valuation-spreadsheet/

http://www.oldschoolvalue.com/valuation-methods/value-stocks-benjamin-graham-formula/


Benjamin Graham Formula
The original formula from Security Analysis is

where V is the intrinsic value, EPS is the trailing 12 month EPS, 8.5 is the PE ratio of a stock with 0% growth and g being the growth rate for the next 7-10 years.

However, this formula was later revised as Graham included a required rate of return.