How to Select NCAV Stocks: Disqualification Over Affirmation

Wouldn't it be better if you could make a lot of money in the stock market without having to pick stocks? Would that ruin the game for you, or would you feel liberated?

Profits Don't Lie

I'm not one of those guys who brags about the stocks that they buy. How could I be? You don't become the talk of the cocktail party by slyly mentioning an obscure box packing company that lost $20 million in the last quarter. Most guys (and I use "guys" deliberately) enjoy telling friends about slipping into a sexy name just before it took off - Google, Amazon, Facebook, Starbucks. If I mentioned the type of companies I bought, they would likely just cut me off from the bar and take my keys.

But profits don't lie. One of the reasons some people find it hard to buy NCAV stocks is because they look so terrible. Unless you were trained in the fine art of NCAV investing, you wouldn't spot a company and instantly know that you had to have it. Most of these companies have suffered some horrible problem which has knocked their stock down to next to nothing. To be perfectly honest with you, the look of some of these companies kept me from investing in NCAV stocks initially, to the detriment of my financial future.

Stack the Odds in Your Favour

The whole strategy behind NCAV stocks is that they will work out as a group together. While roughly 80% of a decently selected NCAV portfolio will work out, investors usually don't know by looking at the companies which ones are sure to take off and which ones will be at the bottom 20% of the pack. There is too much randomness at play for even some of the top Wall Street psychics to be able to select one or two they know will yield monster-sized profits. It's hard (impossible?) to know if companies in an industry are shopping for acquisitions. It's hard to know - unless you have Warren Buffett level talent - which management team is competent enough to tug on their joystick hard enough to right the nosedive or to acknowledge when a problem is too difficult to solve and wind down the company.  I have had companies that I thought were a sure thing flutter around and eventually exit my portfolio at a small loss. Other companies I didn't see much hope in rebounded within a matter of months, nearly doubling in price in the process. All an investor can do is stack things in his or her favour.

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And that's really what it's all about. As a deep value investor, there are a lot of unknowns. Classic Ben Graham investors always talk about margin of safety but when it comes to a company that has been hit so critically a margin of safety becomes paramount. Luckily, given the structure of NCAV stocks themselves, pretty much all net net stocks are conservatively financed but there's more an investor can do. To get the most out of net net stocks an investor must really screen out companies that are obviously bad candidates.

Two Core Characteristics: Low Debt and Not Chinese

For me, part of this means screening out companies that have one of two signs that the end might be near: Chinese management and debt. Of course, I don't mean to screen out companies who hire Chinese managers - that would be racist and obviously wrong - but it does mean that I screen out companies that are based in China or have major operations in China. If you've been keeping up with my little blog then you are well aware of the scandalous behaviour of Chinese companies who gained listing on one of the major American markets. If you haven't then you definitely have to read about it. The second characteristic I always screen out is a high debt level. Debt can do wonderful things for a company when times are good but it can be equally bad when good times turn bad. Debt can make an otherwise manageable hurdle insurmountable and ultimately bankrupt a company. I want to stay as far away from that cancer as possible.

Not that a company with excessive debt will always go belly up but it will happen enough times to make me want to stay away. It also gives a company less wiggle room when it comes to solving the firms current perfect storm of problems. This might mean a longer turnaround time or it could mean that otherwise great options are just not open to the company. When a management team is facing serious issues I want to make sure they are as unobstructed as possible to pursue a great course of action. Debt also makes it harder for a company to be acquired. Some firms want to stay away from debt and wont takeover firms that hold what they deem too much of it. If your company has a large amount of debt on its books then that might be a deterrent to firms who would otherwise buy it.

Invest Smartly - Use the Best Screening Criteria

NCAV stocks are not sexy but they are profitable. The thing that investors have to keep in mind is that buying a net net stock is mostly a process of screening out bad stocks based on good criteria. Set your criteria before you go snooping and then buy a batch of the ones that meet your standards. As already mentioned, two great criteria to use are screening out Chinese companies and companies with too much debt. The latter has even been tested with eye opening results.

There is a lot more that you should be basing your purchasing decisions on. Net Net Hunter members have access to a number of peer reviewed studies highlighting the performance of net net stocks under a wide range of criteria. We also have over 300 net net stocks from 7 different world markets for you to look at. Use our tools and you'll more than makeup for the cost of membership through investment profit. Join now!