Cigar Butt Investing

Cigar Butt Investing (also known as 'Net-Net' or 'Deep Value' investing) is a classic value investing strategy where an investor buys shares in a struggling company at a price significantly below its liquidation value. The name, colorfully coined by Warren Buffett, perfectly captures the essence of the approach. Imagine walking down the street and finding a discarded cigar butt. It's soggy, partially smoked, and unappealing, but it has one last puff left in it—and that puff is free. Similarly, a “cigar butt” stock belongs to a business that is far from wonderful. It might be in a dying industry, losing money, and generally unloved by the market. However, its stock price is so beaten down that it trades for less than the value of its net current asset value (NCAV). The investor buys it not for its long-term prospects, but for that “one last puff” of profit that can be realized when the market corrects the price or the company liquidates its assets. You pick it up, take the free puff, and then throw it away.

This strategy is the brainchild of Benjamin Graham, the legendary dean of Wall Street and Buffett's mentor. In his seminal book, The Intelligent Investor, Graham laid out a quantitative method for finding these dirt-cheap stocks. His goal was to find companies whose market value was a fraction of their tangible assets, creating an enormous margin of safety. The most conservative version of this is the “net-net” approach. The calculation is deceptively simple: Net-Net Value (or Net Current Asset Value (NCAV)) = Current Assets - Total Liabilities Essentially, Graham calculated a company's working capital and then subtracted all other liabilities. If you could buy the company's stock for less than this per-share value, you were effectively getting all the long-term assets—like buildings, machinery, and patents—for free, plus a discount on the most liquid assets. It was a statistical approach; Graham wasn't betting on any single company to turn around, but on a diversified basket of these “net-nets” to, on average, produce a profit.

The cigar butt analogy is crude but brilliant. It highlights the detached, unsentimental nature of the strategy. You're not falling in love with the company; you're just attracted to the price.

A cigar butt company is the polar opposite of a high-growth tech darling. It's often a “fair company at a wonderful price.”

• Ugly Business: These are typically found in declining industries with poor future prospects. Think of a buggy whip manufacturer after the invention of the automobile.
• Purely Quantitative: The decision to buy is based almost entirely on the balance sheet, not on projections of future earnings. The question isn't “Will this company grow?” but “How much cash and inventory does it have right now?”
• The Catalyst: The “puff” of profit comes when the value is unlocked. This can happen in several ways: the market simply reprices the stock closer to its asset value, an activist investor forces change, or the company is forced to liquidate, distributing the proceeds to shareholders.

For Graham, the margin of safety wasn't about a company's competitive advantage or brand strength. It was a mathematical certainty derived from the balance sheet. By buying a dollar's worth of net current assets for, say, 50 or 60 cents, an investor created a buffer against further business deterioration. Even if the company continued to burn cash, the deep discount provided protection. The risk wasn't that the business was bad—that was a given—but that it would deteriorate so quickly that it would burn through its asset value before you could sell.

In his early partnership days, Warren Buffett was a master of the cigar butt approach, using Graham's methods to generate spectacular returns. He spent his days poring over Moody's Manuals, hunting for these obscure, statistically cheap companies. However, over time, and with the influential nudging of his partner Charlie Munger, Buffett's philosophy evolved. He famously quipped, “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

Buffett realized that while profitable, the cigar butt strategy had significant limitations, especially as his capital base grew.

• They Don't Scale: Cigar butt opportunities are usually found in very small companies. It's impossible to invest billions of dollars using this method, as the positions would be too small to make a difference to a large portfolio.
• “Soggy” Butts: The biggest issue is that a cheap company can get even cheaper. If a business is run by inept or dishonest management, it can burn through its asset value before the investor gets their “puff.” The cigar butt can turn soggy and disintegrate in your hands.
• They are High-Effort: Finding these companies requires turning over a lot of rocks and sifting through corporate “garbage.” It's a time-consuming process for a reward that is, by definition, a one-off gain rather than a long-term compounder.
• Potential Value Traps: Sometimes, a stock is cheap for a very good reason and stays that way forever. Without a catalyst to unlock the value, your capital can be tied up for years with little to no return.

In today's highly efficient markets, especially in the United States and Western Europe, true cigar butt opportunities are much rarer than in Graham's time. The rise of computerized screening and the flood of investment analysts mean that such obvious mispricings are quickly spotted and corrected. However, they haven't disappeared entirely. They tend to surface in specific areas:

• During Market Panics: In a full-blown market crash, like in 2008-2009, even decent companies can be sold off to the point where they become cigar butts.
• In Niche or Obscure Markets: Less-covered markets, such as Japan or other parts of Asia, can still offer these opportunities for diligent investors.
• In Micro-Cap Land: The world of very small, publicly traded companies (micro-caps) is often too small for institutional investors to bother with, leaving potential bargains for individual investors.

For the modern investor, cigar butt investing is a specialized tool, not a core philosophy. It requires immense discipline, diversification (never bet the farm on one butt!), and a cold, calculating mindset. For most, Buffett's later advice holds true: focus your energy on finding wonderful businesses that can compound your wealth for decades. After all, who wants a portfolio full of soggy cigar butts when you could own the whole cigar factory?