My 6 Year Net Net Stock Performance
How well does a modern net net stock portfolio perform in 2020?
In February my 6th fiscal year drew to a close allowing me to take stock of how well I've done as an investor. Net nets have had a cult following for nearly 90 years, and have outstanding performance over that period. Interestingly, interested investors can still find them. At the start of 2020, we had around 600 international net nets on our raw screen.
Importantly, the logic behind investing in these beaten down companies has not changed. They’re firms trading below a conservative assessment of liquidation value, well below what a knowledgeable business leader would buy the firm for. This satisfies Graham’s concept of value. More so, most of these firms recover as businesses and begin trading above liquidation value. Some go on to have a bright future. But a strategy that makes logical sense does not perform well each and ever year. Some times the strategy trails the market, testing the resolve of deep value investors...
How Has Value Performed This Past Decade?
The last 10 years have been outstanding for stocks generally. Indices have risen fairly steadily over the last 10 years, one of the longest stretches of uninterrupted market growth in the last 100 years. Firms like Facebook, Amazon, and Netflix have taken the market by storm, and quantitative easing has flooded the market with cash, pushing up the price of high flying growth companies. A handful of firms make up ~40% of the NASDAQ composite index.
On the other hand, for some reason, it's been a terrible decade for value. In fact, as shown below, a $100 investment in US value indices in 2007 would be worth less than $100 in 2017. Ouch! People have dubbed this “the death of value” since it’s the longest period of time that classic value strategies have lagged.
Performance has not improved since 2017 and this great bull market marks the longest period of time that value investing has underperformed growth investing (and by the greatest degree).
The Performance of American Net Net Stocks Since 1999
So where does the poor performance of value leave American-only net net investing?
Not in much better shape. While net nets definitely outpaced value indices as expected, American net nets have failed to beat the market over the recent past. This is the worst showing for net nets in any single country that I'm aware of, which really highlights the fact that value investors should be investing internationally.
Part of the reason for the underperformance is likely due to the flood of Chinese reverse mergers that hit the market in the 2010s. Many China-based frauds that looked great on paper were ultimately classified as net nets which dragged down performance. Back tests I've conducted show a meaningful jump up in performance when excluding Chinese companies. When picking net nets, it really pays to know what you're doing. A lot of investors got sucked into the Chinese reverse merger scam, a problem that Net Net Hunter members easily avoided.
Another problem has to be the death of the hedge fund industry. With so many retail investors shifting cash into index funds, fund managers (the very people who would be fishing for underpriced stocks) have closed up shop. This has made the market less efficient — while it’s easier to find great bargains, the market does not recognize that value in a timely way.
Yet another factors is money printing, which has allowed high ROIC companies to borrow to buy back stock, boosting the share price. This cash has not benefitted the M&A activity in the net net space as much as yo would think if should have.
I have no idea when value will turn the corner in the US markets but I do know three things for sure:
1) While value has significantly outperformed growth (or "glamour") long term, this hasn't been the case during raging bull markets. But, value tends to come back. This may mean that, just as value massively underperformed during the late 1990s tech bubble and then dominated the market over the next decade, we could be on the cusp of a great comeback for classic value.
2) All intelligent investing is value investing. As Munger says, why would you want to pay more for something than it is worth? Eventually those holding on to overpriced stocks will pay the cost of their foolishness. Net net investors will probably want to incorporate growth into their approach in order to take advantage of great business recoveries, though.
3) Smart value investors who think critically about what they're doing and are investing with a long term time-horizon in mind will earn great returns over the long term. Net nets are the best way to make that happen, as they're at the top of the available value strategies. Even in Japan, value stocks performed very well after the 1989 crisis if you were in it for the long term.
My 6 Year Performance
With all of this in mind, let's look at my 6 year returns. This screenshot is taken straight from my Interactive Brokers performance report and shows my account's performance against the NASDAQ and the Russell 2000 small cap index. I edited the name of my account for confidentiality & security reasons, and the indices for clarity:
My performance has performed moderately over the last 6 years. Over the 6 year period, the Hunter Fund is up 133% total, amounting to a CAGR of 15.1%. This is much lower than I would like -- and a drop from my report last year, and behind the NASDAQ's 154% total return, amounting to a CAGR of 16.8%. Also, keep in mind that my performance is net of fees & commissions, but not taxes, while the NASDAQ is a no-fee index.
The Russell 2000 wasn't close, at a CAGR of 8.7%.
The Next Decade
One common piece of advice from outstanding investors is that you can't predict the market. While we're sitting at the highest valuations (at least in terms of CAPE ratio) that we've seen in a long time, that doesn't mean a crash is coming. Again, anything could happen -- the market could crash, rise, or go sideways for a decade as earnings catch up. Investors just don't know. In fact, the only well-placed prediction I've heard about the market is from Buffett: the market will be higher over a 10 to 15 year period.
We also know that value outperforms growth (or as the modern value guys say “momentum”) most of the time... and tends to come roaring back after it underperforms. That suggests a great decade ahead for value.
We’re also sitting at the longest and deepest period of underperformance for value over the last 100 years. Value investors are right to question whether value is dead. But, in this investor’s eyes, value investing is the most rational way for stock pickers to approach investing. Buying overpriced assets just does not make business sense... while buying assets for far less than they’re worth seems like the obvious win.
Your 6 Year Returns... How Were They?
How have you done this past decade?
Net Net Hunter members, such as Clemens, have earned life-changing returns which have really transformed their lives.
"I am 55 years old and net nets freed me from my 9 to 5 job. I have a wonderful life now."
- Clemens, our most inspiring Net Net Hunter member
Yes, these people have learned how to apply the strategy but they've also developed the emotional temperament and fortitude required to earn great returns. They've mastered their emotions and have stuck to the strategy even when times were tough and things weren't working. These are rare traits among small private investors -- but they're absolutely critical when it comes to long term investing success.
Questions and Answers