A couple of fellow Real Money contributors recently wrote a couple of articles on the subject of net-net stocks. These companies' stocks sell below the value of their current assets minus all liabilities. Buying stocks that fit these criteria was Benjamin Graham's core focus in his investment fund, along with special situation and arbitrage.
Net-net stocks were also the original source of Warren Buffet's investment success as a young fund manager. I have always strongly advocated buying these stocks, and my fellow contributors do some excellent work uncovering these gems.
I maintain a list of another set of stocks that are loosely based on the same theory as I search for stocks that trade below their net cash balances. These stocks have a built-in margin of safety since it is rare for a stock to trade for less than a company's available cash for very long . The key to making money with these cheapest-of-the-cheap stocks is to find those names that are not burning through cash. Stocks tend to trade this cheaply for a brief period of time, usually after a negative event or severe market decline. Because of this I keep a list of net cash stocks available on my desk next to my banks and infrastructure lists. If a stock trades temporarily below cash, I want to be ready to buy without having to scramble to do the research.
One stock currently near the top of this list is one I already own: Tellabs (TLAB). I dipped into this stock a few months ago by selling puts and backing into a small position in the stock. This communication equipment company has struggled in recent years amid a weak economy and a very competitive business environment. The company has restructured and reduced its headcount and expenses and appears ready to resume growth when the economy fully recovers.
Tellabs has moved aggressively into the faster-growing, mobile Internet markets, which should start to pay off next year. Although the company is losing money, it is not burning cash. Cash levels at the company are higher now than they were two years ago. The company has $3.36 a share in cash and short-term investments on the books and no debt. The net current asset value of the stock is about $3.42. The total cash and short investments are more than $1.2 billion, so it appears that it has the cash to wait out the economic recovery. If this stock trades down it will become too cheap not to own, in my opinion.
The language-learning company Rosetta Stone (RST) has also traded down below 2x cash balances in recent months. Although it posted a loss last quarter, it is not burning though the cash very rapidly. With the stock trading a bit above $10, the company still has $5.46 a share in cash. U.S. sales have slowed with the economy, but international revenue is better than management's original projections.
The company will probably have some very weak quarters ahead as spending money on learning a new language is a low priority for cash-strapped consumers domestically and internationally. However, the global nature of the world today makes knowing a second language beneficial, and Rosetta should eventually gain from the trend of people becoming bilingual, at least, and perhaps even multilingual. The stock is not cheap enough for me to own, but with 80% institutional ownership and the high probability of negative earnings surprises for the next few quarters, it could easily trade close to the cash levels and make the stock cheap enough to consider. It is on the watch list for now.
Net cash stocks are hard to find. They usually pop up only when the market is at its worst. However, when you can buy a stock trading below the net cash balance it is usually a very low-risk, high-potential opportunity that qualifies as too cheap not to own. Create your list of potential net cash stocks and have it ready in advance of the selloff so you are in a position to act when the time arises.