My 5 Year Net Net Stock Performance

How well does a modern net net stock portfolio perform in 2019?

In February my 5th fiscal year drew to a close allowing me to take stock of how well I've done as an investor. I've mentioned on our Net Net Hunter community forum that you really need to assess performance over a 5 year period, at minimum, to see if an investment operations is working. I've been with Interactive Brokers, and have had access to their great reporting tool, now for 5 years which makes this 5 year mark significant.

How Has Value Performed This Past Decade?

First, some context. 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.

But, 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!

Performance has not improved since then 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.

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.

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.

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 5 Year Performance

With all of this in mind, let's look at my 5 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 absolutely crushed the market over the last 5 years. While the NASDAQ has had an amazing run, my own portfolio has far outpaced it. My total and compound average annual returns were actually better during the summer, but one of my stocks took a major drop, which hit my portfolio hard. Luckily, I ended the year in positive territory.

Over the 5 year period, the Hunter Fund is up 176% total, amounting to a CAGR of 22.5%. This is much lower than I would like -- and a drop from my report last year, but still well above the NASDAQ's 93% total return, amounting to a CAGR of 14%. 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.

What Accounts For My Performance?

Did I get lucky with a big winner? Was I able to ride a single stock to glory? Am I even investing in net nets?

Looking back over the past 5 years, no single stock accounted for a large percentage of my gains. In fact, I haven't had any big winners but have consistently seen 100% gains on many stocks held for 1 to 3 years. My portfolio is also 95%+ invested in net nets. Where I have deviated, I've bought near-net nets (but they haven't added to my performance on balance).

I put my performance down to a few factors: location, selecting top picks, and concentration.

1) Location. I invest internationally, so my returns will differ from US net nets.

2) Top picks. Investing internationally allows me to invest in the best buys available. Since net nets are mostly found in large depressed markets, and you find better buys when more net nets are available, investing internationally allows me to buy better net nets -- the best available. 

It's not just about buying net nets with a better quantitative showing (though that helps!), I'm also selecting net nets that have better qualitative characteristics than the rest. Reading over these past 5 years highlights the fact that Graham, Buffett, Schloss, Cundill, etc, all valued qualitative assessment and used it alongside quantitative analysis earlier in their careers. 

3) Concentration. Rather than running a widely diversified portfolio, I'm running a more concentrated portfolio. This still allows me to take advantage of the statistical return profile of net nets but also allows me to overweight the better opportunities. I'm running a 10 position portfolio, a level of concentration that I feel comfortable with given my current level of skill and experience. As I learn more and become more skilled, I may concentrate even more to take advantage of what seem like clear winners.

While I'm not happy with my current portfolio returns over the last 5 years, they're great when put into context. Few investors even match the market, let alone beat it. over the last 5 years my returns have been tremendous.

The Next 5 Years

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.

With that in mind, it's also impossible to predict where my portfolio will be. While I can't predict market behaviour, I can improve my understanding of net net investing, deep value, qualitative analysis, accounting, as well as my own psychology in order to achieve better returns. Aiming to improve little by little each week means a massive improvement over time, which will eventually translate into even better returns.

Your 5 Year Returns... How Were They?

How have you done over the previous 5 years? 

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, the most inspiring Net Net Hunter member of 2016

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.

How can I help you as a small investor? If there's something I can do, I'd love to hear about it. Feel free to reply to this email. Life is too short to invest badly.

Sincerely,

Evan Bleker

Net Net Hunter

Questions and Answers

Q: Your statement says "Hunter Fund". Do you run a hedge fund?
A: Hunter Fund is my own real money portfolio. It's not open to outside investment but that may change in the future.
Q: You said before that professionals couldn't use this strategy. How big is your portfolio?
A: Assets under investment is under $1 000 000 USD. I don't expect to be able to buy net nets easily if assets rise to over $10 or 20 million.
Q: Can you invest my money for me?
A: I am not currently accepting clients but you may be interested in www.brokenleginvesting.com, our full service investment letter.
Q: Have your returns only been this high due to excessive risk? 
First of all, I don't look at "risk" the same way that academics and professionals look at risk. To me, risk is the chance of permanent loss of capital (probability of loss multiplied by the amount that could be lost), not volatility.
 
If you're sticky about academic risk, according to Interactive Brokers, my portfolio has been much less risky than the market on a number of different metrics. I'll post that here so you can take your pick.
 
 
Q: How much cash do you hold?
A: I try not to hold any cash at any point in time. Doing so will only reduce returns over the course of your life. This past year, due to focusing on implementing a major website upgrade for members, as much as 20% of my portfolio was in cash which cause returns to drag. At this point, all of that cash has been invested and I aim to keep my portfolio as cash free as possible going forward.
Q: Where do you find your net net stocks?
A: I find all of my net nets using our Net Net Hunter Shortlists. I exclude resource exploration firms, pharmaceutical companies, real estate companies, financial firms, and companies that have major operations in China. During 2016, most of the stocks in my portfolio were bought below 50% of NCAV, had no debt, had stable NCAV, had tiny market caps, and some even had PEs below 4x earnings.
Q: Do you invest in any other types of stocks?
A: My portfolio is 90% invested in international net net stocks. Investing in anything else would be a drag on my returns. Graham's net net stock strategy is the most proven high performance value strategy available for small investors.
Q: How can I get those same returns?
A: The first step would be signing up for Net Net Hunter membership. You can do so below.