Does it get any more stereotypical than this?

I've come to appreciate that it's not losses that investors avoid, it's dead money.  Investors will line up like pigs for a slaughter for an investment that is almost a sure loser if someone shouts that it has a small chance of tripling or more.  The losses are chalked up as the cost of doing business with investor proclaiming "just imagine if it did triple or quadruple, then it would have been worth it."  A high risk high reward investment will always have people edging each other out to get a piece of the action.  The types of investments that even company management is embarrassed to associate with are the dead money investments.

Show someone a clearly undervalued company with a history of undervaluation and no catalyst and even the most veteran value managers will turn and run the other way.  A strong bias exists against net-nets with the perception that all of them are dead money, whether or not that's actually true.  I remember listening to a podcast with Geoff Gannon and Jon Heller of Cheap Stocks where Jon mentioned that he thought Audiovoxx was a perennial net-net and might never trade above NCAV.  I owned Audiovoxx at the time and remember grimacing when I heard that.  If this guy who was clearly more experienced in this market thought this investment was dead what do I do?  I didn't do anything, within six months it hit a bout of momentum and traded up to NCAV and then well above, I took advantage of the enthusiasm and sold.

I took a walk at lunch today with my friend Dave, the author of OTCAdventures.  At some point the conversation turned to complex investment thesis and Dave pointed out the simplicity of net-nets, something is worth $2 and you can buy it for $1, nothing more, nothing less.

Net-nets exhibit a return profile that's enviable, in theory buying something for 50% off means a double if the asset reprices.  While the returns are nice the attraction to the theory is investor asset protection.  I realize that by purchasing cash boxes and net-nets I will probably never have world beating investment returns.  Investors buying growing companies at 3x EV/EBITDA will beat the pants off my returns without a doubt.  I'm fine with that, my goal isn't to maximize my returns, but to minimize my losses.  All of the money I have invested is money I saved from working, when I look at my portfolio I can see many stressful projects and remember the hard work required to enable the purchase of my portfolio.

All of this sets the stage for the company I want to talk about in this post, Jemtec (JTC.Canada).  Jemtec is a Canadian company that has staked out a fairly unique niche, they lease out GPS transceivers to monitor prisoners and citizens placed under house arrest.  Jemtec goes to show that having a niche alone doesn't guarantee wild profits and a successful business.  The company has steadily lost money over the past few years.  While the company has lost money at an increasingly slower pace it's still a concern.

The company's management has cut expenses as revenue has dropped.  At first glance it appears the company is grossly over compensating executive management until one realizes that the only employees left at the company are executives.

Jemtec could be classified as a stereotypical net-net, a pile of cash, a poor business, no catalyst, and dead money as far as the eye can see.  Investors are justified in running for the exits on Jemtec as the company slowly circles the drain towards a tax losses.

The company trades for slightly more than 50% of NCAV and losses are so steady that management has predicted down to the thousands how much they'll lose next year!  The company is headline bad, but behind the scenes they aren't as terrible.  While the company lost $138k last year they only had an operating cash outflow of $3800.  Considering that the company has slightly more than $3m in cash, they have close to 100 years of runway to figure out what to do next.

In my view the absolute worst case scenario, and the one most investors are scared of is one where management somehow finds a way to squander or run away with the cash.  Considering that management hasn't done this already, rather they've cut costs in an attempt to save the company, I don't think this merits much concern.  The worst case scenario for management is that they're forced to liquidate and return cash to shareholders, if that happened investors would end up with twice the money they initially invested.

The truth is I, and no one else has any idea what happens next.  An investment like Jemtec is impossible to model, there is no model that handles infinite possibilities.  The company is just as likely to wind down as they are to start selling slap bracelets or pet rocks.  That's the beauty of a net-net though, investors are provided asset protection while they wait to be surprised.  Maybe the company will discover a new way to market their product driving earnings.  Or maybe they'll acquire a completely different company that provides earnings, we just don't know.  As long as whatever happens next isn't as terrible as the market expects the company's stock could react favorably.

Talk to Nate about Jemtec

Disclosure: No position

5 comments:

  1. such a great post. most of my own micro cap net nets are just flat and do nothing forever. until they don't and you come in one day and they double or triple.

    just curiosu what website or software do you use to screen for candian net/nets?

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    1. A friend calls these "one day" stocks, they are flat for ages then suddenly the returns all happen in one day when they double or triple.

      As for Canadian stocks I've used Screener.co in the past, I just sign up for a free trial. I initially ran across this stock in a Globe and Mail article on Canadian net-nets, then a reader sent me an email asking if I'd looked at them, I looked again and wrote this up.

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  2. Great post Nate. And I agree that huge returns might come from investing in cheap and good growing stocks, but asset based investors can have some incredible long term returns as well. Graham made 20% per year, Schloss made 21% for nearly 5 decades, and as you know, both were asset based investors.

    Buffett had higher returns in his partnership, but there aren't many other investors who have (could) replicate Schloss' long term results.

    Also, you may have seen this post, but Geoff Gannon wrote a great post on net nets and toward the end mentions some results from some of the tests he ran over the past 10 years, 20-40% returns (they are likely slightly inflated because of bid-ask spreads and transaction costs, but it still gives you an idea.

    http://www.gurufocus.com/news/161511/are-most-netnets-uninvestable

    Just some thoughts... returns can be quite good.

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  3. with net nets, the only questions should be: a) what is the quality of the assets (inventory in outdated tech parts is worth close to nil); b) how fast are they burning through the assets (e.g., when will it not be an NCAV any more); c) did something in the world fundamentally change that makes them OBVIOUSLY worthless.

    I've made more money on plenty of "dubious" NCAVs (VOXX, PARL, IFON, the list goes on and on) than I've made on the NCAVs that make everyone drool (RSKIA, SODI). I've bought maybe 50 NCAVs, and lost money on maybe 3 or 4. Ben Graham handed us a no-brainer way to make money. Using your brain too much on a no brainer is dangerous!

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  4. Hey Nate,

    Thanks for the write-up.

    There is a great post about Jemtec over here as well.
    http://moatology.com/2014/02/11/jemtec-a-canadian-hidden-champion-trading-at-a-40-discount-to-net-cash/

    When looking at net-nets like this, if the company has consistently traded at a discount to cash or a discount to book what is the basis for believing that this will change in the future? I guess I am referring to the "dead money" you mentioned earlier. Or are you saying that with net-nets in general we should just view this as buying something for less than it is worth, and consider the past market events irrelevant. I guess this boils down to not looking towards the market for support or advice when valuing a company.

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