Update on the Japan net-nets, and a quandary I found myself in

This post is two independent lines of thinking that are related in the end.  If you're short on time, or get tired of my writing each can be read alone, although I'm biased, I think you should read the entire thing..

Japan update

Back in October/November I wrote a post detailing (part 1, part 2) how I wanted to try to buy as many Japanese net-nets as I could using John Templeton's experience as my guide.  My plan was to use Schwab, who at the time was offering free international stock trades.  My plan fell apart when it came to light that Schwab only offered Japanese large caps, they deem small caps too risky for investors apparently.

I was forced to revise my plan.  Because I was going to be paying full commission at Fidelity my position sizes would need to be larger.  To assist in my research I purchased The Japan Company Handbook, which is the Moody's manual for the Japanese market.  The book has a description of each company, historic financials and a number of metrics.  I took the stocks that were scored through the blog, and looked them up in the book.  I then plowed through all of the JASDAQ stocks while commuting to work and picked out the "best".

I was inundated with cheap companies, more than I had capital for.  I started to experience analysis paralysis, I couldn't decide which cheap companies were the best, or what "best" even meant.  Did I want better FCF yields, or a lower NCAV, or better dividends?  In the end I decided that I needed a sound system, one that could be followed and one that was simple.  I decided to buy stocks trading at 2/3 of NCAV, that were profitable, paid a dividend, and were stable companies.  The stable companies criteria is important, I can't tell you how many descriptions in the handbook read like this: "XYZ company was in marketing, now expanding to hotel and car wash ownership, also manufactures headlights, expects new ventures in concession vending."  A company with a description like that is a pass for me no matter how cheap they are.

When I last posted on the Japan companies there was a lot of discussion on whether I should hedge my Yen or not.  I don't have a large enough portfolio that any standard hedging would make sense (futures etc.)  I decided, well inertia decided that I would do nothing.  In hindsight a mistake, but then again if I knew the future I'd be investing differently altogether.

Since the end of November my net-nets have done extremely well, they've almost doubled in Yen terms, and gone up 62% in dollars.  I put together a small comparison spreadsheet showing other potential Japan investments denominated in USD across the same time period.  I even included the hedged Japan ETF as a way to show how the Yen impacted these holdings.

It's worth noting that I didn't start investing in Japan in November of 2012.  I've had a portfolio of net-nets over there for over two years now.  I wrote a Japan net-net retrospective on companies I'd written about last March, at the time those net-nets were up a median of 12.4% against a negative Topix.

Before anyone credits my investing acumen I want to clearly point out that I had nothing to do with these results.  I essentially randomly picked companies that fit my simple criteria and purchased them.  I never read any annual reports, or built any models.  I told myself that I would sell each company when it hit NCAV and recycle the funds into a new position.  I've recycled gains a number of times already.  The performance is my net-net portfolio as a whole, meaning I've had enough gains to offset the two -20% positions I'm still holding, and another -9% position I'm holding as well.

The conclusion from this is that investing in cheap companies works.  As a whole these companies have outperformed the market, and outperformed the currency depreciation.  Yes I could have made more if I hedged, but an argument could have been made just as easily that Japan and the Yen were dead and wouldn't be moving anywhere but up.  Of course everyone now claims they knew the Yen was going to crash, just like everyone claims they saw the housing bubble, or the dot-com bubble.

The quandary

As the Japanese market has heated up I've noticed something strange in my portfolio, most of my stocks will stay flat and then suddenly one will take off like a rocket.  I've had this four times now, it seems to be a weird market pattern.  A net-net will languish below NCAV, and then suddenly in a week or less rise to, or above NCAV on heavy volume.

In staying true to my investment philosophy in Japan I would sell once I realized the stock was trading for more than NCAV.  Recently though a friend was telling me about an experience he had with a Japanese net-net, the stock doubled and he sold it.  It then went on to triple, and eventually quadruple, in a very short timeframe.  During this time one of my holdings Zuken (6947) had taken it's turn to outperform.  The stock was limiting up nightly which is always exciting.

The stock raced past NCAV and I started to think about what to do next.  The problem was as I thought about selling I kept thinking about my friend's experience.  The thought crept in, "I wonder if Zuken will be a double or triple?"

I decided that I would research Zuken, and see if I could figure out why the company was appreciating, and determine a valuation independent of NCAV.  Lucky for me the company had an analyst covering them who said that their 3D printing technology was exciting and investors should wait until the stock hit book value to sell.  The mention of 3D printing further worked to implant the idea that maybe this lowly net-net I had was suddenly going to be a 10-bagger, or maybe even better!

I also found a presentation on the company's website where they discussed their current technology situation and plans for the future.  I don't read or speak any Japanese, leaving me at the mercy of Google Translate.  Unfortunately graphics heavy powerpoint is very hard to translate automatically.  I resorted to copying and pasting in characters a few at a time.

For all my work I came away with the understanding that Zuken believes their profits will double in three years, and that they are doing something with 3D printing in Germany.  The 3D printing seems exciting, although I'm not exactly sure what it is, or what it entails, but the market is happy with this news.

The research also confirmed why I'm investing in Japan by the numbers.  The language barrier is so high that I have trouble completing even enough basic research to be confident in an investment.  Google Translate is excellent at translating European languages, but stumbles badly on Asian languages.

After a few hours of futile Googling and translating I realized that holding Zuken for anything beyond NCAV was being speculative and greedy.  This was a company that had been valued as dead, and now was being lifted high on irrational optimism for their 3D technology.  The market swung from negative to positive so fast I almost missed the move altogether!

I decided to stick to my strategy and sold for more than NCAV, but at about 83% of book value.  I'm happy with my gain, and if the stock goes on to double or triple from here I won't regret selling.  I don't know enough to be confident in my holding, any gains I would have had from here would be purely luck.  I don't mind luck, but I also don't consider it a strategy.

Putting it together

After reading these stories the reasonable question to ask is "what next?"  I'm going to continue to do the same things I've been doing for the last two years in Japan.  I am going to recycle my gains into more net-nets, be patient, and sell when the companies reach NCAV.  I've had some readers ask me what I hold over there, I decided to post it here.  The companies are always in flux.  With the recent gains I'm expecting to add four or five new positions.  The following are my current positions:

If nothing else my experience in Japan has reinforced my experience with net-nets.  The companies are often lousy, and investors shun them, yet the courage to invest and be patient often pays well in the end.  

Disclosure: I own all the companies in the bottom spreadsheet.


  1. Nate,

    I enjoyed this post as much as anything you've written in the last few months because of it's philosophical nature.

    I think you touched on two themes here:

    1.) The importance of following a SIMPLE model, faithfully
    2.) The role psychology plays in investing decisions

    With regards to #1, what complicates this issue is simply your second-guessing of your SIMPLE model. Investing itself didn't become more complicated, just your thinking about your approach. It's tempting to think that you gain some advantage by "handling these things on a case-by-case basis" for example. But for every one you deftly outthink your model, you will probably misread 3 or 4 others. On net, it's a wash, or worse. That's the message the QV guys were trying to get across in their book.

    With regards to #2, what I find so funny is that the investment result pathway (the "Destiny" of the investment) isn't influenced by how you feel about it. The company is going to do what it's going to do and the market is going to respond how it's going to respond regardless of whether Nate feels good or bad about it. I think this highlights again the importance of mastering your own psychology in investing, something Graham, Buffett, etc., have repeated over and over. You talk a lot about emotions in this post (greed, excitement, nervousness, etc.) These security prices are on a "random walk" yet it's resulting in all of these turbulent sensations in your own mind. It is telling how even a sober-minded individual like you was so easily captured by "growth expectations", so to speak. You approached this initially with the calm belief in simple value but suddenly you started calculating the future and you saw all sorts of wonderful visions that tempted you.

    A final point on the role of luck. Luck is not a strategy. But what Graham's whole system/approach is designed to do, is to put luck on your side. This was something the QV book reinforced for me-- it was a systematic way to accrue more than your fair share of luck over time. People talk about Buffett being lucky. Hell yes he was!! But that's why he's a genius, he created an investment system where luck kept finding him. It's different than hoping for luck or expecting luck to do all the work. Luck is still important.

    I enjoyed this and may have to read again to keep thinking about it!!

    1. Frankly, I'm more than a little puzzled by your comment.

      Out of one side of your mouth you cite Efficient Market Theorem (e.g. "security prices are a 'random walk'") and out of the other side you cite Graham and Buffett (e.g. stocks are ownership interests in businesses and thus a reflection of real discounted cashflows / asset values generated by said businesses).

      You cannot have it both ways -- they each disagree with one another.

      Chance ("luck") certainly plays a role in investing (really, what more are we doing than trying to predict an unpredictable future?), but following a structured way of thinking ("a simple model") is not as incongruous from practicing value investing as you seem to think it is.

    2. I surveyed your comment for something coherent and found nothing. Your concluding remark puzzles me as much if not more so than my original comments seem to puzzle you. What do you think you're even saying? Value investing IS a simple model. I don't think they're incongruous and don't know where you got that from.

      The movements of securities prices on a momentary basis are always guided by specific human action and attempts at forecasting and calculating an uncertain future. Because we can't know, most of the time, what is guiding the behavior of securities prices this movement takes a "random walk" from the observation point of a 3rd party. I'm sorry if this is contentious language to use as I understand that specific term comes burdened with an entire theory some people do not agree with (the ability to generate economic profits off security price movements without insider info is impossible because the market is efficient at any given moment in time) but it doesn't change the concept I am characterizing.

      As far as Nate is concerned, the prices he sees being quoted are random. Up one day, down the next. He can't understand their information content. How this is puzzling is... puzzling to me.

      Meanwhile, stocks are still ownership interests in businesses. The behavior of stock prices has nothing to do with their legal/financial/economic status as ownership interests in underlying businesses.

    3. Nate, please chime in.

      Taylor, you're on the wrong website if you believe valuation (what you term "movement of stock prices") has nothing to do with the "financial status" of the referenced business. As for your ad hominems, I don't have any interest in engaging with you further.

    4. I'm not sure what I have to add...

      I agree with Taylor, that simple models work in many cases, there are always exceptions, but they do tend to work. Yet I agree with you that often there's a little extra leg-work required beyond what a model might say, and I know Taylor agrees.

      Yes, a business is going to operate on its own no matter what a stock price does. And yes prices are random walks, over time they coincide with value, but over the short term they jump all over the place.

      The mystery is why over time does a stock price actually come close to matching the fair value of a business? This is the point that Graham pointed out to the US Senate is a mystery, we really don't know how or why it happens. Why can investors get it right sometimes, but not othertimes? No clue.

      I think you guys are talking past each other. I know Taylor, and TboneSam, based on your comments on this site I think you guys have more in common than in disagreement.

      What this post, and emails have spurned is the question of whether a basket approach would work in the US. I think US net-nets are perhaps different? Japan is like the US in the 1930s, lots of net-nets due to apathy and disinterest, now net-nets are mostly companies where management is stealing from shareholders. Something interesting to think about.

    5. TboneSam,

      Might I suggest remedial reading comprehension courses? Nothing I have said so far could be construed as taking the position that security price movements are completely disconnected from the "financial status" of the underlying business. The only way you could arrive at this conclusion if you were a contentious person looking to pick a fight with the first perceived unbeliever (of which I am not one).

      You clearly do not know what an ad hominem is and I'd appreciate it if you'd respect everyone's time by not attempting to defend your confused notion of it in front of all of us.

      As far as being on the wrong website, I come by here quite a bit, I have a value investing blog of my own, I am syndicated on GuruFocus, etc. etc. etc. I am pretty sure I am on the "right website".

      One can often learn more by asking questions of one's betters, rather than trying to pick fights of pedantic issues. But as a lesser one wouldn't expect better behavior of you, would one?

      Everything that happens happens as it should, and if you observe carefully, you will find this to be so.

  2. Great article Nate.

  3. Nate,

    Killer post. I've read tons about net-net investing on this blog and plenty of other places, but I've never done it myself. I think this discussion here really distills it down to the core issues. I read a lot about individual net-nets and they are all dogs with fleas and I've never had the stomach for it, but I think you bring the wisdom and methods of the basket approach to life here. And it sounds like in Japan there are plenty of decent companies that are dirt cheap. Reading this reminds me of Buffett's (or Munger's?) old line that investing is simple, but not easy.

    In your second part, I was reminded of the old investing story about the trader who starts researching the fundamentals of a company when a stock goes against him. Glad to see you stuck with the original plans. I'm sure there are 10-baggers to be had but finding them is a totally different game.

    One question: for these Japanese small-caps, what kind of trading volume did they have?

    1. Greg,

      Glad you enjoyed the post! I don't mind looking at net-nets on an individual basis in the US because there usually are a lot of dogs with fleas as you say. But there are good companies sold down as well. In Japan the market was so neglected that a lot of average companies sold cheap, not just frauds, or ones where management was stealing.

      I'm not sure how well a basket of net-nets would work in the US, but it seems to work well in Japan!


    2. Joel Greenblatt discusses the basket approach often and his work suggests that it does work in the US. Here is a link to a recent interview where he discusses the basket approach: http://www.bloomberg.com/video/joel-greenblatt-says-apple-google-are-bargains-OLzHrZqvRSeS6Es8wapTRA.html

  4. Good article. Perhaps the language barrier was in fact a positive, not a negative. It forces the attention purely on the numbers, and therefore removes at least part of the qualitative assessment.

  5. Hi Nate,

    Really good to see your current japanese positions. Many thanks! I will investigate those companies. I think it would be very interesting that sometimes you publish the changes of this portfolio.

    I am doing my own net-net research in the japanese market, and so far I have found two interesting ones: 1960 and 7885. What do you think about them?

    My objective is to build a net-nets portfolio with 10-15 positions (not only japanese, from other markets as well).

    Many thanks,

  6. Hi Nate,
    Do you discount the AR and Inventory when calculating NCAV?

    1. In the past I have, but for my most recent Japan activities I did not. I just took net current assets minus all liabilities and invested when the market cap was below 2/3.

  7. Have you checked what would be difference compared, lets say nikkei ?

    1. I had not, I just did, looks like the Nikkei is up 52% over the same period, so I slightly edged it out in dollar terms, and almost doubled it in Yen terms.

      The Nikkei is not a good index for comparison, it was created by a newspaper publisher and contains 225 stocks to the Topix's 1700 stocks. The Topix is a much broader index, and is what Japanese investors follow.

  8. Hi Nate,
    I was looking to invest in 7591. However if you look at FCF, it has been negative for the past two years. Do you take into account cash flow from opps and FCF when investing in Net nets?

    1. For a while I was, but once I moved to the simple model no. There are almost an infinite amount of things to look at with these, and it becomes overwhelming. So I shrunk my list down to less than 2/3 of NCAV, profitable (earnings, not CFO), pays a dividend, and sustainable business.

      I was at one point looking at ROE, ROE ex-cash, 10 year EBIT, 10 year earnings, CFO, FCF yield etc. Maybe there's a perfect model that includes all of this, I'm not sure. I went with simple in the end. It's at times frustrating because I'd look at all this stuff in the US, but in Japan I'm taking it on faith.

    2. I have access to S&P's capital IQ. Its a solid system and give you a detailed picture of the company... Everything that you mentioned that you once looked at (ROE, EBIT, 10 year etc). I sent you an email earlier today on another topic - my net nets ideas. If you would like to collaborate, I can send you the spreadsheets that I downloaded from CapIQ.

  9. I think Interactive Brokers may allow you to buy Japanese small caps. Please check them out and let us know.

  10. Japan at Interactive Brokers:


  11. Nate, were you able to use some sort of a computer based screen to narrow down the NCAV discounts first before you read the handbook, or did you literally have to pick them one by one from thousands in the book ? One thing that is a major holdback for me to investigate further into foreign net-nets is the inability to screen and review stocks as you did. Another is the fact that US still provides opportunities in all cap sizes right under our nose here. A tech giant like HPQ was trading 3-4 times earnings as recently as Nov. 2012, which inevitably led to the stock more than doubling since then.

  12. Hi there,

    I've been reading your posts on investing in Japan. One question I have regarding the capital gains tax that are levied. Are they automatically calculated or do you have to fill a return each year.