Could a net-net strategy like I used in Japan work in the US?

In response to the post on my experience investing in Japanese net-nets I received a fair number of emails from readers asking whether I thought such a strategy could work in the US.  I want to explore the answer to that question in this post, and use it as a platform to discuss why net-nets even exist.

I used a simple model to select net-nets in Japan, I picked companies trading for 2/3 of NCAV or less, that were profitable, paid a dividend and were stable.  The stability is the least quantifiable, but actually the one that mattered the least.  I looked each potential investment up in the Japan Company Handbook and read their business summary.  If the company sounded like it would be around in a few years I considered it a mark of approval and continued my research.  What types of companies might be eliminated with this simple check?  A manufacturer of pet rocks, pog, slap bracelets, mexican jumping beans...essentially fad companies.

To answer the question of if this could work in the US I pulled a list of all US net-nets trading at 2/3 of NCAV or less from  I then removed all of the Chinese listed companies, and companies with data errors.  The spreadsheet is below, companies in red are Chinese, and companies in yellow are data errors.  A data error is where a company might appear to be a net-net, but after 20s of examination an investor realizes they aren't.

From the initial 38 companies 29 were removed leaving us with a list of nine potential investment candidates.  There are a few companies on the list that meet some of the investment criteria, but none meet all of them, especially the qualification of paying a dividend.  If that criteria were removed it would be possible to build a portfolio of around a few companies in the US trading below 2/3 of NCAV.  It would be downright risky and irresponsible to invest an entire portfolio in the four companies that are selling below 2/3 NCAV and are profitable.

In light of how few candidates exist I don't think the same strategy could be used in the US as in Japan. But just looking at a screen is only part of the reason, the larger part is why these companies are net-nets in the first place.

The US is the deepest and most liquid market in the world.  I write about obscure stocks and almost half of my readership is non-US readers.  Sit back and think about that for a few minutes, that means that there are people in far flung places on the world that consider US micro cap unlisted stocks attractive enough to research.  There are of course Americans researching them as well, but the smallest and most hidden stocks in the US are still popular enough to garner attention from international investors.  The same can't be said about most other markets outside of possibly London.

Outside times of market distress most net-nets in the US are companies where investors have either given up, or have expectations that are so low the company is perceived to be on life support.  There are times when this isn't true, such as in 2008-2011, at the time many net-nets were companies that were sold down to irrationally low prices from the financial crisis.  Many were average companies that were profitable and weren't on death's doorstep, they've since recovered.

Whereas the US market is loved, and every inch is being researched by investors worldwide, Japan is a different story.  Japan experienced their day in the sun during the 1980s, at that time no Japanese equity was left unturned, most were selling at irrationally high prices on the back of investor enthusiasm. Those high investor expectations came to a crashing halt in 1990, and haven't recovered for the past 23 years.

Much like the US during the Great Depression, investors have completely lost hope in Japan.  Japan as a country and an economy is modern and a participant in the world economy, the same can't be said for their equity market.  The crash of 1990 left a strong impression on Japanese investors, they haven't been seen in the market since then, domestic market participation is 4% of the population.

As investors fled Japan neglect and complacency set in.  Twenty three years is a long time, that's a large part of many people's careers.  A whole generation of investors grew up investing where Japan was a place where money went to die.

Markets are ultimately human driven, and humans are driven by emotions, hence markets are reflections of mass emotion.  This general negative market emotion led to many average or even above average companies selling very cheaply in Japan.  A market where neglect reigns is a value investor's dream, but potentially also a nightmare.  There is no time limit on a long running bear market.  My timing in Japan was completely lucky, or maybe I have been participating in a giant bear market rally, only to see the market dip back to where it was a year ago.

The difference between Japan and the US is there is no neglect or negative view on the US market, rather even the tiniest US stocks attract worldwide attention.  Japan is just the opposite, but as emotions turn opportunities dry up quickly.  When I ran my first Japan net-net screen I found 450 net-nets, a year later the number was 250.  The number is surly lower now, I'd guess less than 100, maybe even less than 75.

This is a really long answer to a somewhat simple question, I guess I could have always just answered "no" and moved on, but those who know me in person recognize how unlikely a one word answer is.

Disclosure: None


  1. You make an important point about timing. The time to invest net-nets and similar is after a major market dump. In 2002 and 2009, with help I had a list of stocks trading for less than cash minus all liabilities, there were numerous stocks in which you could buy cash at a discount valuing the rest of the business and assets at zero! Analysis showed you could have bought them as a basket and more than doubled your money two years later. What's left now are the dregs. Maybe there is a diamond in the rough somewhere. Bottom line is that this isn't the time to be diving into deep value stocks. This is currently a liquidity driven bull market that is raising all boats. If the debt crisis hits the inevitable wall as I expect it to within the next ten years, there will be another opportunity. In the meantime the best thing to do is go with the flow.

  2. It's interesting that this post popped up: I've been struggling through this too :)

    What makes a mechanical net-net strategy compelling is that it provides an absolute measure of value versus a relative one. You can always find a group of the lowest P/B stocks, but creating a portfolio of 2/3 NCAV stocks is not always possible. Since the number of net-nets seems to go up and down with the general level of the market, maybe this could be used as an indicator to put more of your portfolio in cash or in overseas net-nets.

    Additionally, for US markets, a 2/3 of NCAV followed by a quality screen may not be the right way to go about it. Geoff Gannon has written about several net-net backtests, and he has always used the looser definition where a net-net is just a stock where current assets minus total liabilities exceed market cap with no impairment to the asset accounts. Some of these backtests returned upwards of 40% per year.

    The NCAV trifecta looks to be high insider ownership, F-score, and Z-score. I think you could look at the stocks in greater detail, but those metrics end up being a pretty good proxy for what an analyst would want in their stock portfolio.

    Insider holdings makes the most sense since greed alone should be sufficient to ensure there are enough "pops" as companies are taken private, go dark, or are sold to drive the net-net returns.

    Additionally, the more I look at F-score, it's not just a quality metric, but also has a slight momentum aspect to it since you are looking at year on year improvement in certain categories. We could almost call it a measure of fundamental momentum.

    One problem I'm having is "shaking out" all the net-nets. Even using simple screens between GuruFocus,,, Portfolio123, and others, and looking at exchanges like the NASDAQ, I do not get the same stocks. Once a list has been collected, I'd hand check whatever metrics I could, and then invest according to the insider holdings and F-score values as Geoff has mentioned.

    Beyond this, I would consider doing an unlisted net-net portfolio that follows the stronger form 2/3 of NCAV. Nate mentioned TTHG yesterday, which is on, and it's trading around 40% of NCAV. My goal would be to build a basket of 10 such stocks, or even less in combination with a looser net-net portfolio like Geoff's, and then hold for 2-3 years.

    I don't see how this could generate returns less than the market in the long-run. Maybe not 40%, but even 10% would provide more return than what most investors are expecting long-run from the S&P 500 at its current level. And unlike a S&P 500 fund, I can be assured that there is some level of asset backing along with manager's own money at stake in these stocks.

    However, I'm still a complete novice in implementing something like this, so any advice related to how to screen and ensure that the figures I need for F-score and insider holdings are accurate are greatly appreciated! Thanks so much!