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Risk In Net-Nets

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In my last net-net article I said I’d discuss the issue of technology risk at net-nets. I scrapped that idea. I have a good reason. I decided I wasn’t qualified to talk about the subject. Instead, I’m going to talk about risk generally. How risky are net-nets? How should we price a net-net? Should we use probabilities? How can we invest in businesses that are so inherently uncertain? That sort of thing.

A net-net is a stock selling for less than the value of its current assets – cash, receivables, inventory, and prepaid expenses – minus all liabilities. Basically81, it’s a stock selling for less than its liquidation value.

In normal times, very few stocks trade at such a low level. Today, there are 132 net-nets. Compare this to the number of stocks that could be net-nets. Generally, a net-net will not be in financial services or real estate. Technically, this isn’t impossible. But the kind of net-nets we are looking for – actual operating businesses selling for less than their current assets per share – are almost never found in these two sectors. So, if we narrow the universe of possible net-nets down to U.S. stocks that aren’t in financial services or real estate we end up with roughly 4,800 candidates.

Of course, some of those 4,800 stocks will never be net-nets – no matter how much investors hate them – simply because their current assets are less than their total liabilities. A net-net – by definition – must have higher current assets than total liabilities. Otherwise, there would be zero chance that the stock’s price could be lower than the excess of its current assets over its total liabilities. If current assets are less than total liabilities, a stock will never become a net-net – even if it trades at $0 a share.

So, how many stocks could actually become net-nets?

That number is lower. Right now, it’s about 2,100 stocks. This is the number of U.S. stocks outside of financial services and real estate that have current assets greater than total liabilities. Any of these 2,100 stocks could become net-nets today if only investors traded their shares at low enough prices. For these 2,100 stocks, the question of whether or not they are net-nets is answered by investor sentiment.

Link: http://www.gurufocus.com/news/156019/risk-in-netnets/affid/61447

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