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Balance Sheet Investing Strategy: A Review of Graham net-net by kcchongnz
Balance Sheet Investing Strategy: A Review of Graham net-net
“If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume.”
I first wrote about this Graham net net on September 6 2013 here:
http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/36493.jsp
My itchy fingers wrote it again on 23th January 2014 here below.
http://klse.i3investor.com/blogs/kcchongnz/45296.jsp
The reason I was interested in this investing strategy is because plenty of academic research has shown that this strategy has yielded very good results in the US market. One of the nearest-to-pin disciples of Graham, Walter Schloss purely followed this strategy and has yielded wonderful results with CAGR of 21.3% compared to 8.4% of S&P for a period spanning five decades as shown below:
http://klse.i3investor.com/blogs/kcchongnz/50988.jsp
Comments on Graham net net investing strategy
So far the response to this strategy from the i3investors forumers has been lukewarm at best as shown from some of the comments below:
“investors should look into investing in businesses that can generate wealth from their existing assets and grow, not from the view of how much they will get if the company liquidate their existing assets” keanpoh
“KC, what is the likelihood that Kuchai will trade closer to its net asset value in the future ? For me, looking at these type of Graham net net there must be some catalyst that would unlock its value or else we could be stuck very long time holding them with significant opportunity cost.” NOBY
“The market always discounts potential value trap at required rate of return on equity. You may invest in value play based on Balance Sheet but ultimately it is FCF that counts when determining fair value.” sense maker
It is understandable as this strategy of investing is a very boring strategy. Few people are interested in investing by looking at the balance sheet (shit?). Revenue and profit growth, directors frying their shares, big contracts awarding, striking oil etc are always the prevailing themes.
So what is this Graham net net strategy of investing? Here is a review.
Graham net net strategy
Graham net-net is an estimation of the liquidation value of a company as shown below.
Net Net Working Capital = Cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) – total liabilities
It's the lowest form of valuation you could possibly do because it ignores everything about the business and just focuses on tangible assets. The formula states that;
• cash and short term investments are worth 100% of its value
• accounts receivables taken at 75% of its stated value because some might not be collectible
• take 50% off inventories, due to discounting if close outs occur.
So if one buys the stock with market capitalization below the Graham net-net value, he would very sure make money eventually. This was what Graham said.
“The idea here was to acquire as many issues as possible at a cost for each of less than their book value in terms of net-current-assets alone – i.e., giving no value to the plant account and other assets. Our purchases were made typically at two-thirds or less of such stripped-down asset value. In most years we carried a wide diversification here – at least 100 different issues.”
What is my experience in Graham net net investing then? My experience is indeed too short a time frame. Nevertheless I will still provide some non-statistically significance figures here just as a guide.
My experience in Graham net net investing strategy
I started this strategy of investing about a year ago as a “diversification” from my earnings based “Magic Formula” of Greenblatt. Here is the results as shown in Table 1 in the appendix below at the close of today’s market of some of the net net stocks picked throughout the past one year.
The net net portfolio set up within the past one year returned 34.6%, more than twice the return of the broad market of KLCI of 16.0%. It is really not bad at all for a safe balance sheet investing strategy. Heads I win, tails I don’t lose (much).
I have hence decided to continue this safe strategy of investing for the near future in view of the prevailing market conditions and the position of the swing of the investment pendulum.
K C Chong (19th May 2014)
Appendix
Table 1: Return of net net portfolio as on 19th May 2014
|
Graham net net return |
|
|
|
|
|
|
|
No. |
19/05/2014 |
Ref price |
Now |
Dividend |
Gain/loss |
return |
|
1 |
Daiman |
2.630 |
3.480 |
0.120 |
0.97 |
36.9% |
|
2 |
KSL |
2.020 |
2.170 |
0.000 |
0.15 |
7.4% |
|
3 |
Plenitude |
2.100 |
2.910 |
0.060 |
0.87 |
41.4% |
|
4 |
Insas |
0.630 |
1.200 |
0.010 |
0.58 |
92.1% |
|
5 |
PMCorp |
0.150 |
0.220 |
0.000 |
0.07 |
46.7% |
|
6 |
Hexza* |
0.635 |
0.755 |
0.050 |
0.17 |
26.8% |
|
7 |
Prkcorp |
2.820 |
3.590 |
0.000 |
0.77 |
27.3% |
|
8 |
Kuchai |
1.200 |
1.450 |
0.000 |
0.25 |
20.8% |
|
9 |
KESM |
2.040 |
2.520 |
0.030 |
0.51 |
25.0% |
|
10 |
FACB |
1.260 |
1.530 |
0.000 |
0.27 |
21.4% |
|
|
|
|||||
|
|
Average |
1.55 |
1.98 |
0.03 |
0.46 |
34.6% |
|
|
KLSE |
1627 |
1887 |
0.000 |
260 |
16.0% |
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Discussions
2 people like this. Showing 38 of 38 comments
Very Good For Fundamentalist Investors!
My Experience In i3 Forum & also in Investlah show that more than 80% of the people DO NOT BELIEVE In Long Term Value Investing.
This Is What One Value Investor Told Me. "
70% of The Chinaman Bosses are not educated and they have made their money from businesses. They are not well versed with accounting - so they depend on friends or Star paper or Nan Yang Siang Pau for tips or rumours.
Their Accountants know figures but have little interest to study investment or to teach their bosses as there is no incentive to do so. So this is the scenario - the Bosses have money but don't know how to invest properly. And the Accountants know how to read figures but have no money (after deducting house & car loans there is little money left) so they don't bother about investment.
This appalling state has created 2 markets in KLSE. The Group who speculate on rumours and a small group of True Investors.
I think Ben Graham, Walter Schloss or even Warren Buffet will be happy to find Undervalued Gems in KLSE - Totally Overlooked by The Gambling Crowd
2014-05-19 20:00
pmcorp and hexza the last cheap counter of Graham Net Net!
Disclaimer: trade at own risks
2014-05-19 20:46
Remember there is Only One time gain if there is Any. Do you guys see the difference yet???
2014-05-19 21:01
Ayam Tua, you tell everybody here How Long have you been waiting already for HEXZA to go up to Rm1.00? I thought you are too Old to wait?
2014-05-19 21:05
stockoperator: AyamTua means I can wait sampai tua.. why the fast? Hexza mah.. slow slow but moving .. kikki
2014-05-19 21:07
Posted by stockoperator > May 19, 2014 09:07 PM | Report Abuse
I did not mean Nasty ya. I treat everybody here as good friends ya.
faham.. no worries .. kikiki
2014-05-19 21:08
KC how are you allocating your portfolio between asset plays and magic formula stocks today ? How many pct for each ?
2014-05-19 21:15
Ok Ayam Tua you sudah.
And My Dear Calvin, if you want to become Net Net Calvin, have you bought 60-100 counters yet?
2014-05-19 21:17
And my very dear KC, i think you forget to list down last-time Proton and Now Mas among others yet ya?
2014-05-19 21:18
abang stockoperator: Proton and MAS as Graham net net? I opine abang KChongnz knows what he says .. hihihi :-)
2014-05-19 21:21
NOBY, i think KC writes this articles just for fun and challenges us.
After reading so much of his article, KC IS NET NET IN BUSINESS Value.
2014-05-19 21:23
OK lah most of all are tempted to be Net Net for awhile. But you know he is holding Pintaras, PresBhd, Kfima, Padini among others what?
2014-05-19 21:32
Like FACB, Now Net Net because of High Cash and we should invest. That means if company invests in machine and equipment to expand Business, it becomes Non Net Net and we should not invest. LOGIC OR NOT?
2014-05-19 21:38
Ini memang last liao. Yes as Business Owner the first thing i look at is Healthy Balance Sheet, but then No Business What to Buy?
2014-05-19 21:53
hexza still got business .. vinegar..
pmcorp still got business .. chocolate ..
no business , people close shop liao loh ...
ha.. ha.. ha dont worry, kcchongnz principle of investment strategy is safe .. I have been his follower.. proven rock solid methodology.
infact if one follow his investment (rock solid) one will notice in one year time frame.. capital still intact mah with earning lagi ........ kikiki .... dont look into price, look into safety and value...
both kcchong and calvin tan have same pattern : safety and returns and long term ... sleep soundly , peacefully what matters ...
2014-05-19 21:57
nowadays people look into action more.. if want fun in investment: then put 70% boring stock with 30% punting stock..
this way wont be old to wait.. e.g. asiabio, nextgram, smrt, k1, megb, masterskill all these put 30% .. and 70% boring stock like hexza, ntpm, kuchai, etc etc (those researched by kcchongnz)
to me.. when kcchongnz mention his stock pick - it's should be ponder upon too..
believe kcchongnz selections more to safety, rock solid and less entertainment .. boring stock ... but people wont lost that bad what ... by putting things into timeframe beat 10% CARG from market y-o-y basis.. bla bla..
believe me, kcchongnz KNOWS HIS STUFF.. :D
remember: 70% rock solid 30% punting if really want actions :D
2014-05-19 22:03
If property stock, think hard to use, as most assets are prop dev. Then would u consider Gbh and kela di?
2014-05-19 23:45
If we look at Balance Sheet and Profit and loss and cash flow statement in totality we can conclude that Equity/Asset produces Profit and profit generates cash flow. And ultimately QUALITY cash flow is the blood flow of Business. Is it fair?
If the above statement is fair, then it must be fair to say that if cash flow is low/negative then profit must be irregular and that must be something wrong with the management in deploying the asset or even the asset is of low quality. As such the asset has little Business value at the moment.
Even if the asset is of High quality, it is still up to management willingness and capability and know how to unlock the asset value. So it is still fair to say that the High quality of asset is of little Business value at the moment if the value has yet to be unlocked. Is it not fair?
Well, if you invest in 60-100 stocks, I would not deny that some might be high flying above its NTA due to turnaround, some might be closing the gap to NTA, some might be privatized, some might get new management, some might venture into New Business, ..whatsoever.
Well, it is speculation against hard fact investment. What else can I say?
2014-05-20 03:02
Overall there is no evidence that net net graham has outpaced Business value investment short term long term bad time or good times if we take overall 60-100 stocks as a whole Not a few shortlisted one.
The main reason is lack of Insider Move. The Boss knows the accounting value and Business value more than anybody else right? Why there is No insider Move?
1) Timing and Condition must be right;
2) Accounting Value Yes but No Business Value;
3) Situation is worse than we all perceived;
4) The purpose of listing has been met
Well all sort of Rumor will be associated with this typed of companies.
2014-05-20 09:44
Any company that has the management capability to unlock cash value/asset value will see a Huge move for next ten years as DCF model is working Now. And i don't want to miss the Boat as well.
2014-05-20 11:49
One of the criteria of graham net net is that the company does not bleed cash or making huge losses as this would in the long run deplete its cashpile. DCF models eventually come up with the intrinsic value by adding the present value of future cashflows as well as the excess cash a company has today. That excess cash/liquid assets which is present in Graham net net type stocks provide you a huge additional margin of safety in the intrinsic value. I have valued many companies using DCF and those having a strong balance sheet always had a bigger margin of safety even with the most conservative growth assumptions.
2014-05-20 12:47
Posted by NOBY > May 19, 2014 09:15 PM | Report Abuse
KC how are you allocating your portfolio between asset plays and magic formula stocks today ? How many pct for each ?
I have no fixed rule, but at the present situation now, I tend to lean more towards balance sheet investing, a lower risk strategy.
Earnings, and hence ROIC can change much quicker than asset value.
2014-05-20 14:28
Is margin of safety a specific located price for people to hide? Or market drops 20% and your portfolio managed to drop 10% that is margin of safety?
Or should we think that margin of safety is where 90% of broad market drops But i am holding the balance of 10% that will continue to perform well.
2014-05-20 15:28
I know the mentality of managing own funds and other people funds are different.
2014-05-20 17:07
But my experience is that customer would prefer clear communication and clear strategy.
2014-05-20 17:13
I know it is wrong of me to comment on different investment style as risk rewards of individuals are different and Nothing is absolute right and wrong.
2014-05-21 17:40
Posted by stockoperator > May 20, 2014 03:28 PM | Report Abuse
Is margin of safety a specific located price for people to hide? Or market drops 20% and your portfolio managed to drop 10% that is margin of safety?
Or should we think that margin of safety is where 90% of broad market drops But i am holding the balance of 10% that will continue to perform well.
For me, even if my stock dropped 20%, or part of the 90% of the broad market to drop, as long as I have clear idea on its value, I would buy more if I have the cash as the margin of safety would have increased if the price drop is not related to fundamentals. Price volatility is to be expected when investing in the stock market and they are the result of the temperament of the market participants. Like KC mentioned, in the case of Graham net net, asset values change much slower than earnings, which would you prefer to hold in current market condition ?
2014-05-21 17:48
I am the advocate of portfolio diversification instead of stock diversification. It is a new Horizon that is why it is called efficient frontier. We Really need to open up.
I am also learning cash management as I dont want to have a cash call or into the situation of what you said i would buy more if i have cash.
I want to make sure i am well prepared at all time and Nothing surprises me. This requires certain sacrifices in term of yields and mentality to think in the context of Eternity.
Ultimately My portfolio needs to survive so we can only talk about realization of long term compounding.
2014-05-21 20:36
You know what i mean? we should not talk about 15% or 20% or 25% ? But after 30 years where are we right?
2014-05-21 20:53
A High conscious mind looking beyond your fear and greed and emotion generated from our own thoughtlessness. Then you know of survival ship, eternity,...long term compounding, peace of mind in investment..in fact everybody knows and i am just reminding.
2014-05-21 21:04
Kcchongnz, I'm confused whether one should minus minority interest when calculating net net working capital. Please enlighten me.
2014-08-03 11:58
Dear KC, in the case of property stocks, do you mark down "Property Development Costs" which is classified under Current Assets. Thank you.
2015-05-28 10:32
Posted by mahorse > May 28, 2015 10:32 AM | Report Abuse
Dear KC, in the case of property stocks, do you mark down "Property Development Costs" which is classified under Current Assets. Thank you.
All depend if the property development can sell well or not. If it can, then it may even worth more than its book value; otherwise it may not worth much at all.
2015-05-28 11:28
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AyamTua
yes ! hexzaaaaaaaaaa
2014-05-19 19:58