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Recent Success of Net-Net's


Shane
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There are a lot of blogs I like to follow that discuss investing in Net-Nets.  I was wondering if anyone knows of someone with a solid track record that invests heavily in these over the past 10-20 years?

 

Do most of you all seek out net-net's?

 

The world has changed and I wanted to hear other's opinion of whether the strategy is still worth the effort!

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Unless they return money to investors each year, a solid 10-20 years probably precludes them from a current Net-Net mandate.  That is, they'd now have too much money to employ in net nets.  I'm sure there is someone out there doing it, but if they are any good, they probably do other stuff too.

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I invest in net-net's write about them on my blog, maybe you're referencing me, who knows.. anyways

 

I've done well with them, but it's really only a small portion of what I do reason being there just aren't enough quality net-net's to fill a portfolio at this point.  I know it's an oxymoron but net-net land is 1/3 falling knives, 1/3 value traps, 1/6 companies teetering on the brink of bk and 1/6 potentially good investments.

 

As for a track record, I know Tweedy Brown did some research on them that was updated by Oppenheimer in the 80s.  Basically there is enough of a record going back to Graham in the 30s up to the 80s.  You can find some of that out on greenbackd.  Montier did some number crunching on them as well although the paper regarding returns isn't available online anymore.

 

I have a thesis someone sent me that studied net-net returns from 1984-2008 there were some interesting conclusions.  The first being value weighted (cheapest get the highest weight) beat the market but only by a few points, 3% over 1 year, actually lost on a 3yr, and about 6% on a 5yr basis.  What's fascinating is an equal weighting strategy crushed the market, almost doubled the market returns on a 1/3/5yr basis (rolling periods for the entire time).

 

Here's part of the reason why this is hard to be successful with, I've attached a graphic showing the number of net-net's in the US each year since 1984, and the number of net-net's trading at less than 66% of NCAV.  Remember my breakdown above, given 100 net-net's you might have 16 that are worth a shot, for a few years in the 80s there were only 6 net-nets at all, not good odds.

 

For myself I invest my own money (6 figure portfolio) so I'm not bumping into any problems with size, heck I could probably run a 100% net-net strategy for 10 years plus before I got priced out of some of the smaller ones.

 

I've had the same observation as you, a lot of value bloggers writing about the same stocks.  When I see that it means that a lot of investors are probably in there as well, I'd rather go in uncharted territory, so I have traveled abroad in search of net-net's.  I've ended up purchasing a few across Europe and Japan.  I've ended up making contact with some value bloggers/investors looking at net-net's in Europe and Japan but it's a VERY small group, almost non-existant compared to the US.

 

I'm also digging into some of the unlisted stocks people have never heard of, lots of discounts there as well.  Just found one today, company trading at 90% of NCAV (which is mostly cash and marketable securities) earning $1 a year trading at $11.80.

 

I'm long winded, sorry.  I guess if you had to boil this down, net-net investing isn't as easy as some might claim, and two look where no one else is looking. 

 

Thoughts?

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Oddball - Yes I do have your blog bookmarked, it is one of the favorites.

 

I agree with what your saying.  I see very few net-net's out there that are really compelling and usually these are very complex, which is probably why they exist.  I've only ever invest in 1, and looked at 40-50!

 

It seems to me in order to really build a portfolio you can't just focus on net-net's anymore unless your comfortable being very concentrated on complex situations and are a very confident analyst.

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You'll have better success in India.

 

Also as a rule of thumb, Countries that don't have well established securities markets will yield the best results, though from time to time the US, CAN, and EUR will offer attractive opportunities.

 

To do well with net-nets you have to be competent with financial statements and only pick out those that aren't bleeding cash or have some messy situation that few are willing to look into-yada, yada.

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Many of the Bermuda P&C companies are net nets by a strict definition or a modified definition.

 

I think it's very profitable to look at an expanded concept of net net the way Marty Whitman does by looking at the net market value of the assets of the business. This might be the liquidation value of the business or what a willing buyer would pay for the whole company.  This means that it's possible frequently to uncover a great business that's a net net by an expanded definition and rarely by the tight definition. Bermuda is a good hunting ground, especially because there are no corporate taxes there, and no taxes on UK companies that have Bermuda affiliates and write policies off shore in the international markets.

 

For example, in the spring of 07 LRE had been in businesses a little over a year and had had hardly any losses since their IPO at the end of 05.  It was a great business run by the best Lloyd's underwriter in the 80's and 90's.  It had assets that were very liquid and hardly any of the assets were set aside as reserves as losses had been negligible.  Q1 and Q2 of 07 were low cat loss quarters, and I realized that this great business was going to be a net net at the end of Q2 by the strict Ben Graham definition.  I said WOW!  I'm going to write this up and send this in as an application to become a new member of VIC. 

 

I sent the writeup in to VIC and heard nothing from them.  Then, that summer I noticed that someone else had written up LRE on VIC a few weeks after I had sent in my write up.  In truth, that analyst had done a much better and longer write up than mine which had been limited to their requirement of no more than 500 words for new submissions.  Nevertheless, I got ticked off and wrote a letter of complaint about it to Joel Greenblatt but never heard back from him.

 

Now, most of the Bermuda P&C  companies are selling way below BV/SH, and with solid reserves and high quality, liquid assets are true Ben Graham definition net nets.  Theoretically, any of these could be put in runoff, and those that have mostly or entirely short tail property books could return about the market value of their stock prices to their shareholders within a year and the remainder of value after that, enhanced by significant reserve redundancies that most have.

 

But runoff would be shortsighted because most of these are good businesses whose stock prices have suffered through a soft market that is now starting to turn.  This is a perfect situation for superior returns in the future.  In summary, this is not a recent success, but much better because it's forward looking.

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You'll have better success in India.

 

How reliable are the financial statements in India?

I have done net nets in india. Financial statements are reasonably reliable ...you may have corporate governance issues in some cases

 

You can find a decent number of net nets as there are 5000+ listed securities. however at the same one can do far better with good companies. also in a lot of net nets the company and management is terrible and that makes your stomach churn

 

I think after doing nets nets for a few years in india, i have found good companies selling at decent valuation to be more profitable and a far more pleasent experience

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You'll have better success in India.

 

How reliable are the financial statements in India?

I have done net nets in india. Financial statements are reasonably reliable ...you may have corporate governance issues in some cases

 

You can find a decent number of net nets as there are 5000+ listed securities. however at the same one can do far better with good companies. also in a lot of net nets the company and management is terrible and that makes your stomach churn

 

I think after doing nets nets for a few years in india, i have found good companies selling at decent valuation to be more profitable and a far more pleasent experience

 

I have done net nets in india. Financial statements are reasonably reliable ...you may have corporate governance issues in some cases

 

You can find a decent number of net nets as there are 5000+ listed securities. however at the same one can do far better with good companies. also in a lot of net nets the company and management is terrible and that makes your stomach churn

 

I think after doing nets nets for a few years in india, i have found good companies selling at decent valuation to be more profitable and a far more pleasent experience

 

Agreed. Also most companies (including net-nets) in India are majority owned by a promoter. So Ben Graham's thesis that a company trading for less than NCAV will eventually be bought out and liquidated doesnot necessarily hold true i.e. the promoter is not inclined to maximize value and the net-net forever remains one thereby becoming a value trap.  Most of my successes with net-net investing in India have occurred only when there was an immediate catalyst or significant downside protection via a nice dividend yield.

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I thought only Indian citizens could buy Indian stocks, is there some sort of loophole?  I remember looking into this recently as well as seeing someone post about it on the board. 

 

Here's an article I found: http://jayesh.profitfromprices.com/invest_in_india.htm

 

I classify as a foreign non-Indian, so it seems I'm out of luck.

 

Foreign institutional investors are already allowed to invest in India. Infact Fairfax has made some investments in India in the past before they started Fairbridge Capital out here. The govt is also thinking of opening the indian equity markets to freign retail investors. See article below:

 

http://www.dnaindia.com/money/report_govt-mulls-direct-share-buys-by-foreign-retail_1614115

 

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Agreed. Also most companies (including net-nets) in India are majority owned by a promoter. So Ben Graham's thesis that a company trading for less than NCAV will eventually be bought out and liquidated doesnot necessarily hold true i.e. the promoter is not inclined to maximize value and the net-net forever remains one thereby becoming a value trap.  Most of my successes with net-net investing in India have occurred only when there was an immediate catalyst or significant downside protection via a nice dividend yield.

yes that correct. one reason you can find a lot of net nets in india is due to poor to non existent capital allocation skills of the promoter/ manager

There are several business like textiles, auto parts etc where the core business generates attractive returns on invested capital, but the excess capital is not returned back to the minority shareholders via dividends (buybacks are very rare and barely understood). These promoters who in some cases hold more than 70% of the stock, have no concept of shareholder value and just hold on to the cash

So the graham thesis of liquidation does not work in such cases. In addition take over laws are not clear , so you dont have takeover attempts on such companies.

 

In effect you can see the value, but never realise it - classic value trap.

 

 

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How do you even begin finding net nets in India? Is there a screener or a paper guide?

 

i think there are paid screeners available. I have however done it the hard way - go through numbers manually one company at a time and build my own list using website like moneycontrol.com

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Though it is true there are a lot of closely held companies selling below net working capital, depending on the amount of money you have to invest and the country from which you are investing, you can definitely stir up the applecart in India. 

 

Here's a potential second present for those of you paying attention. Hirco PLC

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Though it is true there are a lot of closely held companies selling below net working capital, depending on the amount of money you have to invest and the country from which you are investing, you can definitely stir up the applecart in India. 

 

 

Matt - I would be interested in knowing of any previous instances of 'stirring up the apple-cart' in India. The only example I can of in 'recent' past was the takeover bid on GESCO by Sanjay Bakshi. See link below. And even in that case, it was a recently spun-off company with promoter-holding at ~ 15%.

 

http://www.icmrindia.org/casestudies/catalogue/Business%20Ethics/The%20Tug%20of%20War%20over%20Gesco%20Corporation.htm

 

I guess you could consider the lititgation following the FCCB investments that QVT has made in certain Indian cos or the ongoing litigation between bondholders and Wockhardt management but I perceive those as more of an attempt to protect their capital on the part of nvestors as opposed to an iitial investment with the intent to shake-up the management.

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Someone wanted to know where to find data on Indian companies.  Consider this an early holiday present.

See the Attached PDF.  Here is a Scribd link as well: http://www.scribd.com/doc/75608280/Indian-Net-Nets-13-Dec-2011

 

 

Matt,

 

First, thanks for the link.

 

Second, there's got to be a lot of phony baloney stuff on that list because the first five companies have net working capital that's ten times more than their market caps.  Unlike the Chinese companies that took over NA shell companies that are virtually all frauds, some of these Indian companies have to be legitimate because of local scrutiny and regulation.  How do you ferret these out?

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Someone wanted to know where to find data on Indian companies.  Consider this an early holiday present.

See the Attached PDF.  Here is a Scribd link as well: http://www.scribd.com/doc/75608280/Indian-Net-Nets-13-Dec-2011

 

 

Matt,

 

First, thanks for the link.

 

Second, there's got to be a lot of phony baloney stuff on that list because the first five companies have net working capital that's ten times more than their market caps.  Unlike the Chinese companies that took over NA shell companies that are virtually all frauds, some of these Indian companies have to be legitimate because of local scrutiny and regulation.  How do you ferret these out?

 

Matt - Thanks for the list. 

I have a major part of my investment portfolio in two companies listed in the first page.  I won't name them - but one is a case of bad corporate governance with related issues of delayed recovery of A/R and such; the other is a pure case of market discounting recent results heavily.  It is a pure case of supply-demand mismatch in the market for the first and just over-reaction for the second.  In the first case, my thesis is to be able to accumulate enough to force a change in operating style.  In the second, I am waiting for market to correct.

I see some other names that are on my wishlist (the ones I would buy at a deeper discount).

twacowfca - i am immitating what i read about Walter Schloss with this portfolio.  I started just recently down that path since quality was over-priced by foreign investors rushing in to buy in the last few years.  I don't have enough of a history to share with you as a result. 

I am primarily a fundamental investor.  My sources are the 52 wk lows page in economictimes (you can get a copy of it online) and a database from capital-market.com, a local publication that offers industry-wide filters.  From there i pick up the financials - soft copy from business-beacon.com or recent ones from bseindia or sometimes from other paid sites that offer free soft copy annual reports and take my research from there.

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Matt,

 

First, thanks for the link.

 

Second, there's got to be a lot of phony baloney stuff on that list because the first five companies have net working capital that's ten times more than their market caps.  Unlike the Chinese companies that took over NA shell companies that are virtually all frauds, some of these Indian companies have to be legitimate because of local scrutiny and regulation.  How do you ferret these out?

 

twacowfca, I did not filter any of these out, just provided a list.  If I were currently looking at Indian net nets, I would start by looking at the balance sheet to see what line items make up the bulk of working capital.  Naturally, I'm first looking for cash & securities to be large, but the point is to identify companies that are likely to have easily identifiable assets of value. Next I'd look for companies without L-T debt or at least make sure the companies have the capacity to pay down debt.  I'd then look at the income or P/L statements and eliminate most companies bleeding large amounts of cash.    From there I would focus on the most compelling opportunities-clear catalysts are a definite plus.  You could do simple background checks on directors, see how mgmt have allocated capital (divs or buybacks) in the past.  One really big factor I'd pay close attention to is whether or not management are consistently raising capital through debt and/or stock issues.  This is generally a bad sign.  Like the problem with most money managers, the more assets the bigger the fees.  Same mentality is true to a large extent in India, if the companies expand, Management's salaries increase-and you can point to an ungodly number of companies that have expanded for no other reason than for the benefit of Management remuneration.

 

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