In a previous post on Boss Holdings I looked back at the history of two net-nets from 2007, Boss Holdings and Concord Camera. The post started the gears in my mind asking questions like "How did other net-nets fare over the past decade?" or "Does a longer time frame result in higher returns?", and "what about those net-nets not purchased at market lows?" I don't have any stock databases at my fingertips so I asked Geoff Gannon to run some point in time searches for me. A big thank you to Geoff!
This post is the first part of a three part series.
First off I think it's helpful to consider what Ben Graham said about net-net investing and market conditions:
"It may be pointed out, however, that investment in such bargain issues needs to be carried on with some regard to general market conditions at the time. Strangely enough, this is a type of operation that fares best, relatively speaking, when price levels are neither extremely high nor extremely low." (Graham, Security Analysis 6th edition, p571)
What Graham contends is that when the market bottoms it's much better to buy quality companies that have fallen disproportionately with the market rather than focus on net-nets. I would agree with this with the caveat as you'll see below, market bottoms offer opportunities to buy "quality" net-nets, companies that have long records of profitability and are selling below NCAV. There's no reason an investor couldn't combine investment styles, purchasing some quality companies cheap as well as quality net-nets in a low market.
Of course the data shows that net-nets purchased in 2002 and 2009 with long strings of profitability rewarded shareholders. This is an obvious conclusion, buying almost anything at a market bottom had positive returns. These are the results of the point in time screen Geoff ran for me. The picture shows the results of the screen, there are the important pieces of information. First is the ticker and company name. The start column is the price at 6/15/2002, and end is the price at 6/15/2012, or the buyout price. The other columns are self explanatory, but I want to highlight the last one, it's the number of years with positive earnings. Here are the results:
As a comparison I imagine a hypothetical portfolio where someone invests $1000 equally into the ten stocks. For comparison I use the Vanguard Small Cap Value Index with the same starting sum and same date range.
Starting sum: $10,000
Net-net investor: $16,558
Index investor: $14,511
Net-net investor outperformed by 14%.
I should also note none of these figures include dividends, they're prices only. The index is price return as well, so it should be a good comparison.
Sure raw data is nice to look at, but I'm always fascinated with the stories of the actual companies. So in VH1 style I went and dug around to find out what these old net-nets were up to now.
Blair - Bought out in 2007 by Appleseeds and Golden Gate Capital. A value investor talking to management was the catalyst for this transaction.
Friedman Industries - Still trading and looks decently attractive, 5.2% dividend, P/E of 9x.
Electro-Sensors - Still trading, it hit $11 back in 2006 but has generally traded in the $2-4 range since the early 1990s.
Refac Optical Group - Bought out by a Private Equity firm in a LBO.
Books-A-Million - Going private. I want to make a mention with them, if a shareholder purchased in 2002 and held on they'd be looking at a 25% gain over the last ten years. This masks the fact that coming out of the 2002 recession Books-A-Million shares climbed almost 10x topping out close to $25. It's a shame the shares didn't do the same thing the second time they found themselves in the net-net bin.
Allou Healthcare - It turns out this net-net was a massive fraud. Execs booked phony sales, inflated inventory and eventually burned down their warehouse. Fraud is always a concern with net-nets, I have a post coming up on this in the very near future.
Ambassadors International - The data appears incorrect on this one, the company is around and trading at $5.18 a share. The company has made some acquisitions over the years and is slightly profitable.
BCT International - Management bought out shareholders in 2003. The company appears to still be operating. I find it ironic that in the news release mentioning the going private transaction it also notes earnings grew 59% and revenue grew 10% that year.
Control Chief Holdings - They executed a reverse merger and went dark, very dark. To get financials one needs to be a shareholder, and becoming a shareholder isn't easy. I've had bids out at times over the past year without getting a hit. The last trade supposedly took place in 2011. If anyone has information on this company please email me below.
TransNet Corporation - The company struggled through the decade and has been consistently losing money over the past few years. They haven't been able to file with the SEC for the past year. They're literally a penny stock, their price is 1¢.
The results from 2002 were pretty remarkable, as a group an investor who purchased the top ten did very well. It's interesting that the results are polarized, companies either went to zero, or recovered nicely. There are no companies on that list down 30% over the decade, if there were losses they were total losses.
Here are the companies from 2009:
My first observation is that five of the ten are still net-nets! The good news is that the share prices haven't remained flat the entire time. Here's how the hypothetical investor would have fared investing $10,000 equally into these stocks using the same criteria that I mentioned above.
Starting sum: $10,000
Net-net investor: $17,457
Index investor: $14,191
Net-net investor outperformed by 23%.
In both cases of buying at the market bottom the pure net-net investor came out ahead of someone buying the value index. The difference between 2002 and 2009 is that since 2009 there haven't been any total losses yet.
Superior Uniform Group - The company has recovered strongly coming out of the recession by doubling profit.
Flexsteel Industries - I wrote them up last August, I don't believe they're a net-net anymore.
Abatix Corp - Still a net-net, there's a great writeup about them at OTC Adventures.
Nortech Systems - Still a net-net, I just looked at them recently, they're steadily plodding along.
Performance Technologies - The chart for them is a line steadily sloping down and to the right, not a good sign. It appears their earnings have taken the same path.
Movado Group - This stock's outperformance came pretty recently, it had traded in the $10 range until the end of 2011 when the company stopped losing money and reported profits.
TSR - Still a net-net, Whopper has covered them here.
Lakeland Industries - A net-net that's taken a turn for the worst, they lost an important court case that requires them to pay $10m. This company has also been covered by Whopper.
RF Industries - The company's results have been lumpy over the past few years but their price has recovered and now the company sells above book value with a P/E of 39. Just as the market can overshoot to the downside, it can overshoot on the way back up as well.
Paradise - This is still a net-net and a bit of a niche hidden champion. Despite still selling below NCAV the company's results have improved and the share price has reflected that.
A general observation is that none of the top net-nets in 2009 were bought out or went private. The ones that performed well were due to company results improving. In a few cases it looks like the market went from overly pessimistic to overly optimistic.
In the next part of this post I'm going to take a look at what happens when an investor buys net-nets in a market that's neither high nor low.
Talk to Nate
Disclosure: No positions