They're not around much anymore, especially following bull markets. But Ben Graham's net-net working capital opportunities are a classic special situation worth remembering.

In a net-net situation, an investor estimates a liquidation value for a company, then tries to pay a fraction of that value in the market. Ben Graham loved these types of situations, defining the net-net value as:

Cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) - total liabilities

Graham looked for companies whose market values were less than two-thirds of that net-net value, for two reasons. First, he wasn't sure he would receive the full value for accounts receivable and inventory before paying off the creditors. Second, he wanted to make sure he had a margin of safety to fall back on, in case it didn't work out. After all, if the market valued the company this low, something was certainly wrong with it.

Graham's idea was to bet on a situation with asymmetrical odds. In such situations, the probability of losing money is fairly high, but the magnitude of any loss would be small. However, the potential payoff is large, despite having a lower probability of success. That's why these situations are special and worth looking for, even today.

An endangered species
Net-nets aren't completely dead, but they're tough to find today. And good luck ever finding one that meets Graham's two-thirds value rule! Plenty of value managers out there know about them and aren't afraid to commit capital as soon as they pop up, even at small discounts to their value.

Should we give up on them? No way. Net-nets are an important tool in the value investor's toolbox, because they can be very lucrative.

I checked the archives from the end of 2002, and found a few interesting situations that have done quite well, and a few that really haven't done much of anything at all.

Ambassadors International (NASDAQ:AMIE) ended 2002 with a net-net-to-market capitalization ratio of 0.93. It wasn't low enough for Graham, but at less than 1, it was still selling below its pseudo-liquidation value. Since then, shares of the cruise, travel, and events-services company have increased 460%. Not bad for a company the market temporarily left for dead.

Another example is Internet and mobile search technology company Infospace (NASDAQ:INSP). At the end of 2002, it was basically selling for the cash on its balance sheet, with a net-net ratio of 1, very little in terms of accounts receivable, and no inventory. It's up 209% since then, and legendary value investor Seth Klarman picked up shares after its swoon in the latter half of 2006.

You win some, you lose some
I'm not here to sell you on the idea that net-nets are sure things. Optical-networking products maker Sycamore Networks (NASDAQ:SCMR) hasn't worked out as well as many had hoped. Sure it's up 34% since the end of 2002, and value investors Third Avenue and Chapman Capital have become interested, but it's essentially trading for the same ratio today as it was then.

Another stock from the end of 2002 that shows up on today's list is order-fulfillment software company Selectica (NASDAQ:SLTC). It's actually down 28% over that time period, because the value of the company has been falling in step with the amount of cash on its balance sheet -- and Selectica's it's been burning cash along the way.

I hope you see the power of Graham's thinking. Even if the businesses don't improve, the downside of a net-net can be limited. If you're patient, you may even be able to beat the market by a little bit if you're patient.

Today's bargains
You can see a potential net-net prospect today in CallWave (NASDAQ:CALL). The communications application software company is selling at a ratio less than 1, trading for less than the cash on its balance sheet. Sales have been declining for a while, but the company has been able to remain roughly cash flow-neutral. Thus, if the company can turn things around, it could be an interesting opportunity. However, we have to understand the probability of that occurring before we can make an investing decision, especially since this is a very small company.

One company on the list that does not fit the net-net mold is Plug Power (NASDAQ:PLUG). While it's trading for about the cash on its balance sheets, management is burning through that cash faster than a hot knife cuts through butter. Thus, as with Selectica, Plug Power's value is likely to dwindle further as its cash supply dries up. Plug Power needs to get some more products to market, and quickly.

The Foolish bottom line
It's good to get back to your roots once in a while. That's why I wanted to share some thoughts on Ben Graham's net-nets. These special situations, while somewhat rare, offer investors a unique way to increase returns while taking on less risk. That's a combination we can all use.

Spice up your portfolio with more Foolish coverage on special situations

Do you consider yourself a special-situations investor, or are you interested in learning more about these opportunities? Tell us about your interests in our very brief Special Situations Investing Survey. Your comments will help us develop future content to fit your needs.

Sometimes, small companies sell at deep discounts to their value. That's when Tom Gardner and Bill Mann at Hidden Gems really get excited. To see what gems they've uncovered, click here for complete access to our small-cap newsletter service, free for 30-days. Now that's a value play!

Retail editor and Inside Value team member David Meier learned about evaluating great companies and special situations at Wake Forest. He does not own shares in any of the companies mentioned. He is currently ranked 675 out of 25,209 investors in The Motley Fool's CAPS rating service. You can view his TMF profile here. The Fool takes its disclosure policy very seriously.