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Net nets and compensation expense


bennycx
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Hi All,

 

I've been looking through a couple of net-nets in declining industries and I keep seeing the same pattern over and over again. The companies have a pile of cash sitting in the balance sheet and the market is trading near net cash where you get the business for free, however the business is earning negative to zero earnings. Compensation is large part of expense with the executives earning huge salaries relative to the market cap. CEO does not want to return cash as they want to use it to grow or expand.

 

So finally I inverted and thought if I were in the CEO's shoes what would I do? I would do exactly the same! If I knew the industry is declining I would pay myself as much salary as possible so that shareholders get zero. Why would I take the risk of owning the shares when I can be guaranteed income by paying myself a salary. I also wouldn't return cash to shareholders otherwise I will be out of a job.

 

Anyone else has the same experience looking through net-nets? I find it really hard to find a good one to invest in. They all seem cheap but are really not that cheap.

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Yes, you are right in your thoughts.

 

When Graham talked about net-nets, he talked about profitable net-nets. I don't have exact quote off top of my head, but he did not suggest buying money losing net-nets.

 

Unfortunately, in this time, there are very few profitable net-nets, usually microcap and/or international.

 

Others might be able to give you examples. I have not bought net-nets personally recently.

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I am a big proponent of net-nets, operating in South East Asia and they are quite common.

 

One thing I've learned researching this particular "strategy" is that its really a group operation. I've seen net-nets with excessive compensation which go on to triple. I've seen net-nets that look great on paper, but never re-value (talking about 3 years here).

 

All I can say is that its a group operation. I haven seen little by way of correlation and causation. Also, there's a study which shows that net-nets with negative earnings out-perform those with positive earnings... so there you go.

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I agree with theasiareport on diversification in net-nets.

 

Does anyone use Piotroski score on net-nets? Theoretically, it should improve the results. Practically, I don't know since I have not bought money-losing net-nets. :)

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When Graham talked about net-nets, he talked about profitable net-nets. I don't have exact quote off top of my head, but he did not suggest buying money losing net-nets.

 

Anyone else remember this differently?  I think Graham mentioned in Security Analysis that unprofitable net-nets often did better than profitable net-nets

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Even if research says unprofitable net-nets outperform profitable ones, I will still select the profitable ones and the ones with normal compensation and not excessive. Just using some common sense thinking here...

 

I am a big proponent of net-nets, operating in South East Asia and they are quite common.

 

One thing I've learned researching this particular "strategy" is that its really a group operation. I've seen net-nets with excessive compensation which go on to triple. I've seen net-nets that look great on paper, but never re-value (talking about 3 years here).

 

All I can say is that its a group operation. I haven seen little by way of correlation and causation. Also, there's a study which shows that net-nets with negative earnings out-perform those with positive earnings... so there you go.

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That's my instinctive reaction. But that's probably why they out-perform seeing that even us bargain hunters avoid them. Reversion to the mean at play here.it

 

I wouldn't pick them individually, but as a group, there seems to be plenty of evidence they out-perform.

 

The only question is whether someone has the emotional capacity to implement it.

 

Even if research says unprofitable net-nets outperform profitable ones, I will still select the profitable ones and the ones with normal compensation and not excessive. Just using some common sense thinking here...

 

I am a big proponent of net-nets, operating in South East Asia and they are quite common.

 

One thing I've learned researching this particular "strategy" is that its really a group operation. I've seen net-nets with excessive compensation which go on to triple. I've seen net-nets that look great on paper, but never re-value (talking about 3 years here).

 

All I can say is that its a group operation. I haven seen little by way of correlation and causation. Also, there's a study which shows that net-nets with negative earnings out-perform those with positive earnings... so there you go.

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When Graham talked about net-nets, he talked about profitable net-nets. I don't have exact quote off top of my head, but he did not suggest buying money losing net-nets.

 

Anyone else remember this differently?  I think Graham mentioned in Security Analysis that unprofitable net-nets often did better than profitable net-nets

 

No need to rely on memory. I have the book and Jurgis is correct. Graham steers investors towards net-nets that are decent companies as an example of an egregious mis-valuation.

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When Graham talked about net-nets, he talked about profitable net-nets. I don't have exact quote off top of my head, but he did not suggest buying money losing net-nets.

 

Anyone else remember this differently?  I think Graham mentioned in Security Analysis that unprofitable net-nets often did better than profitable net-nets

 

No need to rely on memory. I have the book and Jurgis is correct. Graham steers investors towards net-nets that are decent companies as an example of an egregious mis-valuation.

 

Now I hate to argue with someone who's publicly stated that they've read Security Analysis four times, but I don't believe Graham had any problems with money-losing net-nets.  I remember that one of the examples he gave in the liquidation value chapter was a net-net that had loss years but a history of profitability.  I'd agree that he suggests decent companies and he even gives a list of characteristics that the companies might have, but I don't believe an earning history without a loss year was a problem-he would be more concerned if a company had a big reduction in liquidation value instead.  We might just be disagreeing about what money-losing means, if it's just one bad year or a bad earnings record over a number of years.

 

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I've been investing in "net nets" and "great companies at reasonable prices" for the past 6 years and in my experience I don't see one strategy significantly outperforming the other. One of the toughest problems I have is how do we compare a net net to another company already in your portfolio? To put it concretely, suppose you have 3 great companies and a basket of a 10 net nets and you find another net net. Would you invest in the 11th or would you add more to the 3 great companies assuming they are cheap as well? People tend to be in one camp or the other and no one has really given me a good answer to this. I find that focusing on the great companies tend to be better as it takes away reinvestment risk of the cigar butt

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When Graham talked about net-nets, he talked about profitable net-nets. I don't have exact quote off top of my head, but he did not suggest buying money losing net-nets.

 

Anyone else remember this differently?  I think Graham mentioned in Security Analysis that unprofitable net-nets often did better than profitable net-nets

 

No need to rely on memory. I have the book and Jurgis is correct. Graham steers investors towards net-nets that are decent companies as an example of an egregious mis-valuation.

 

Now I hate to argue with someone who's publicly stated that they've read Security Analysis four times, but I don't believe Graham had any problems with money-losing net-nets.  I remember that one of the examples he gave in the liquidation value chapter was a net-net that had loss years but a history of profitability.  I'd agree that he suggests decent companies and he even gives a list of characteristics that the companies might have, but I don't believe an earning history without a loss year was a problem-he would be more concerned if a company had a big reduction in liquidation value instead.  We might just be disagreeing about what money-losing means, if it's just one bad year or a bad earnings record over a number of years.

 

You may be thinking of Tobias Carlisle's paper, in which the basket of net-nets that posted a loss in the most recent TTM beat the basket with net-nets that were profitable in all recent years.  http://greenbackd.com/category/about/net-current-asset-value-about/

 

The specific word Graham uses in Security Analysis was to be "discriminating," by which he means the net-net should have some other quality statistical features, or have a catalyst, such as about to undergo some positive management change, declare dividends, or undergo liquidation.  So you might be right that an unprofitable net-net imminently about to be liquidated might be o.k. by Graham, but I do not think he explicitly uses such words for a general strategy.

 

The two approaches are probably mutually exclusive.  Graham says to be selective and discriminatory.  Gray and Carlisle in Quantitative Value say that one should strictly stick with the results of your screen.  They say that cherry-picking introduces the hazard of unconscious mental biases, for example when they tried to pick and choose "better-looking" stocks within the screen, these picks underperformed.

 

I think either approach will work, but the caveat may be to be consistent for the long term through thick and thin.  Sticking to a consistent strategy is one of the hardest traits for investors, even value-investors.

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  • 6 months later...

I agree with theasiareport on diversification in net-nets.

 

Does anyone use Piotroski score on net-nets? Theoretically, it should improve the results. Practically, I don't know since I have not bought money-losing net-nets. :)

 

Jurgis, I think the idea of using the P-Score for net-nets is very interesting so I wanted to bump this thread to see if anyone else did this for net-nets

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  • 3 weeks later...

I agree with theasiareport on diversification in net-nets.

 

Does anyone use Piotroski score on net-nets? Theoretically, it should improve the results. Practically, I don't know since I have not bought money-losing net-nets. :)

 

Jurgis, I think the idea of using the P-Score for net-nets is very interesting so I wanted to bump this thread to see if anyone else did this for net-nets

 

I use the F-Score for selecting net-nets. I don't have that long practical experience from it though, 2-3 years. I have done some studies on the subject. For google translated versionf of them, se links below (originally written in Swedish).

 

https://translate.google.se/translate?sl=sv&tl=en&js=y&prev=_t&hl=sv&ie=UTF-8&u=https%3A%2F%2Fvardebyran.wordpress.com%2F2014%2F10%2F20%2Feuropeiska-net-nets-i-kombination-med-f-score%2F&edit-text=

 

https://translate.google.se/translate?hl=sv&sl=sv&tl=en&u=https%3A%2F%2Fvardebyran.wordpress.com%2Fnet-nets%2F

 

 

 

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I agree with theasiareport on diversification in net-nets.

 

Does anyone use Piotroski score on net-nets? Theoretically, it should improve the results. Practically, I don't know since I have not bought money-losing net-nets. :)

 

Jurgis, I think the idea of using the P-Score for net-nets is very interesting so I wanted to bump this thread to see if anyone else did this for net-nets

 

this looks great, thank you, looking forward to reading it!

I use the F-Score for selecting net-nets. I don't have that long practical experience from it though, 2-3 years. I have done some studies on the subject. For google translated versionf of them, se links below (originally written in Swedish).

 

https://translate.google.se/translate?sl=sv&tl=en&js=y&prev=_t&hl=sv&ie=UTF-8&u=https%3A%2F%2Fvardebyran.wordpress.com%2F2014%2F10%2F20%2Feuropeiska-net-nets-i-kombination-med-f-score%2F&edit-text=

 

https://translate.google.se/translate?hl=sv&sl=sv&tl=en&u=https%3A%2F%2Fvardebyran.wordpress.com%2Fnet-nets%2F

 

 

 

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