Net-Net vs. Free Cash Flow: 4 Kids, Kraft

This was originally published on RealMoney. It is being republished as a bonus for TheStreet.com readers.

The famous value investor Ben Graham was an advocate of investing in "net-nets." These are companies that are trading at less than what the cash, receivables and inventory are worth, minus total liabilities. There are not a lot of net-nets to be found, but you can find a few.

The problem is that often when you invest in a net-net, management spends down the cash in succeeding quarters. So when you revalue your stock, the company has less cash. And unfortunately, the stock reflects this fact.

Case in point: 4 Kids Entertainment(KDE Quote). 4 Kids produces several cartoons for Fox Television (NWS Quote) and repurposes these cartoons into trading cards and games for children. Last September, the stock was at $15, and the company held $122 million in current assets and no debt. The market value was about $200 million.

Unfortunately, 4 Kids has burned through $45 million in current assets and now is trading at half of what it was last year. On top of that, management instituted a shareholder rights plan, a "poison pill," to prevent shareholders from gaining access to that cash. That is the hard part of net-nets. Investors can't ever access the cash, because management puts in too many safeguards.

Another company with a similar situation is IDT(IDT Quote). IDT started off selling long-distance telephone cards. When that business got too competitive, it spread into new enterprises such as animation, debt collection, ethnic groceries and a hodgepodge of other stuff.