rukawa Posted October 22, 2016 Share Posted October 22, 2016 Traditional value investing consists essentially of investing in low price to book companies. In traditional studies of market anomalies there appears to be out performance that comes from low P/B stocks which are identified with "Value" and also an additional alpha that comes from small cap stocks. Normally Net-Nets are considered as a variant of low P/B investing. But one thing observed with Net-Nets is that they get considerably higher returns than low P/B and additionally a lot of the out performance cannot be explained either by value or the size effect. Typically the best performance you get from both value and small cap effect together is less than 20% a year. But net-nets returns are usually substantially in excess of 20% a year. For instance the following study finds returns of 2.55% monthly which translates to 30% a year http://csinvesting.org/wp-content/uploads/2015/01/Benjamin-Graham-s-Net-Nets-Seventy-Five-Years-Old-and-Outperforming1.pdf Even more surprising is that you get even higher returns when you invest in negative enterprise value stocks. This study finds 50% a year https://blogs.cfainstitute.org/investor/2013/07/10/returns-on-negative-enterprise-value-stocks-money-for-nothing/ Basically net-nets are like low price to book except that instead of including the fixed assets you zero them out completely. In the Net-Net paper by Tobias Carlisle that I cited NCAV (net current asset value) stocks are defined as: Liabilities including preferred stock - current assets. You buy when the stock trades at 2/3 of NCAV. This values all current assets including inventory and accounts receivable at 100%. Negative Enterprise value is a different calculation in that it relies on market values but in some sense the Negative enterprise value calculation can be considered nearly the same as the Net-Nets if you assume that debt trades at par. The only difference is that you completely zero out accounts receivable and inventory. Basically I would summarize this as follows: Negative Enterprise Value Buying Rule Buy when Cash - Debt > Market Cap Return: 50% a year Net-Net Buying Rule Buy when (2/3)*(Cash + Inventory + Accounts Receivables - Debt) > Market Cap Return 30% a year The fact that enterprise value > Net-Nets > Low P/B seems to indicate very strongly that in any asset based value investing strategy it hugely pays to buy stocks that are cash rich. Cash really is King. Link to comment Share on other sites More sharing options...
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