When Do You Sell a Net/Net?

 |  Includes: DPII, LENS-OLD
by: Jon Heller, CFA

Here at Cheapstocks, we devote plenty of time and space to companies trading below their Net Current Asset Value. We attempt to identify those that we believe have a solid shot at survival, and the ability to ultimately deliver a nice return to those investors willing to take the risk. But the question that sooner or later must be answered is "When do you sell"? The easy but often incorrect answer is that you sell when the the company is no longer a net/net. All else being equal, that is exactly the time to hang on.

Net/Net Perspective

Consider that net/nets are still quite rare, and most companies trade at large multiples to net current asset value, if indeed their NCAVs are even positive. To put that into perspective, consider that Coca Cola (NYSE:KO), for instance, has a negative NCAV to the tune of $3 billion! Tootsie Roll Industries' (NYSE:TR) NCAV is $38 million, and with a market cap of around $1.5 billion, trades at 40 times NCAV. (We are not comparing any of the companies we've identified in our research to either of these, but simply trying to put net/net multiples into context.) Companies trading below their NCAVs, assuming there is any life left, are potentially trading at bargain basement prices.

The time to sell a net/net is when the reasons you purchased it in the first place are no longer valid. The fact that a company trades at a discount to it's NCAV is just the starting point in the analysis-there need to be compelling reasons or a catalyst that will catch the market's attention, attract investors, and ultimately drive the stock price higher.

Many of the net/nets we research are either profitable, have a large amount of cash relative to market cap, have what we believe are undervalued assets on the books, or a combination of the three. In the case of a company with at large amount of cash, (recent examples are DPII and LENS) should the cash burn rate increase, it's time to bail.

In conclusion, net/net investors need to keep their eye on the ball. As we are fond of saying here at Cheapstocks, companies trading below their net current asset value are often "cheap" for good reasons. The trick is finding those with a little life left. Happy hunting.

Disclosure: Of the stocks mentioned in this post, the author has a position in DPII and TR.