Benjamin Graham - the father of value investing mentioned about the opportunities of Net-Net in which companies are selling below their net current realisable asset (realisable net current assets minus liabilities).
As it is a mathematically easy formula to follow plus the advent of Bloomberg and computer, it soon become pretty hard to find much decent Net-Net opportunities. In today market, the companies which are still selling at Net-Net usually demonstrate the following characteristics
loss making and will soon turning into net liabilities
industry is seen as Passé
look and smell like a fraud
apocalypse fearing management who is incapable of doing anything with their cash holdings
majority shareholder/management who is milking the company dry through management compensation
Searching for Net-Net had also become automated and unrewarding. Anyone who had blindly followed the formula in recent years would have a very bad experience. Once a while you would come across an article which uses a Bloomberg screen to create a list of stocks which are selling at Net-Net.
While the unwise would take that as an investment list, most would dismiss the list due to the reasons above.
Variant Perception + Net-Net
While the investment returns from Net-Net had been generally bad, it is also an extremely easy way to get a good investment story if you have a variant perception from the market.
A few possible scenario can happen
the company is in a cyclical industry and the industry is turning around
the company is getting out of a loss making business and had redeployed assets into profit generating ones
it is actually a rose around the shits (that why it look and smell like a fraud)
there is a change in the management thinking and the cash is deployed as dividend, share repurchase or reinvestment
litigation, or the cow is dead...
Some of our really “ancient” Net-net position:
When some of the SGX listed China companies were exposed as fraud, all the honest China companies' share prices got hammered as well. Some happened to be in the cyclical industry and was doubly affected. If you had recognised that that some of the companies are actually a rose or the industry is turning around, you would have been handsomely rewarded.
Kingboard Copper Foil was a company which is in Net-Net for years with zero motivation from the majority shareholder and management until some threat of litigation appeared. Swiftly, the shares move beyond their current assets.
Midland IC&I had been selling below cash valuation for various period. While nothing much happened to the cash (except for mildly unprofitability during an industry downturn), the share price decreases when Hong Kong goes on protest and improves when the protest goes away.
Our recent “Net-Net” position:
We had recently highlighted Hanwell in our Position Update on the 27th August 2020.
We issued a Trade Alert on 10th September 2020 telling everyone that we are more than halving our position after the share run up.
While it seems that Net-Net opportunities should be arbitrage away in this era of fast computing, we can continue to see possible Net-Net opportunities around. Since most of these opportunities have smaller market capitalisation, they are still very much accessible to the everyday opportunistic investors.
Some Rules for Trading Net-Net:
The most important aspect of building a Graham Portfolio is to understand that we are not building a long term portfolio.
We must maintain strict discipline to
set a clear target price to buy when it is selling at a huge margin of safety
ignore the market perception as this is usually an unloved company
be comfortable to deal with illiquid shares and be able to opportunistically buy them on the market
size the positioning appropriately. For us, it is usually 1% of the portfolio. For you, please decide what is your comfortable risk profile.
sell when the market offer you fair value or beyond.
not understand why the market will offer us such opportunity to buy and sell and we are just there to take advantage of it.
understand that we are there to make a potential short term profit and not fool yourself into making it into a big or permanent position.
to maintain self discipline in not deviating from your target price.
We will be highlighting some of the Net-net opportunities soon. If you are interested in this list where we will only be putting 1% sizing in each position. Do hit subscribe button below.
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