Value Investing? Here's the Big Secret for the Small Investor

This article is a guest contribution by Net Net Hunter member Matt Carey. The opinions expressed here are solely those of the author. 

Acquiring wealth is one of the most important things a person should do, but how?

You invest, of course.

A savings or money market account is not going to cut it. CNN money says the average bank is going to get you about .06% APY (average percentage yield). $1000 will yield 60 whole cents a year. Slow down, Tiger.

60 cents is not very exciting, but what about the money market accounts? Money market accounts usually pay higher interest and are considered a safe savings strategy. Unfortunately, the average money market account yields just .85%, not even enough to cover the cost of inflation. In other words, your $1000 would yield just $8.50 (Did that blow your hair back? I certainly didn’t feel the breeze.) but that same $1008.50 would actually erode to well under $1000 in real spending power by the end of the year. Those are underwhelming returns, to say the least.

Start Value Investing for Great Returns

When it comes to amassing wealth, you really have to look at investing in stocks. If you’re a small private investor, then net net stocks are much more rewarding. As a small investor aspiring to build a net net portfolio, there’s really no better place to start than downloading our Net Net Hunter Scorecard or even signing up for Net Net Hunter membership.

Evan’s proven to be a great resource for learning how to apply this strategy. The first thing he advised was to focus on reading and learning. I didn’t understand why at the time but looking back I really appreciate the guidance. Evan’s recommended reading list set me up with the correct mindset for solid investing. Yes, Evan claims that small investors should be able to nail down 25%+ average annual returns, but this isn’t a get rich quick scheme. Achieving 25%+ average annual returns requires your willingness to learn, apply, and stick to the strategy over the long term.

Benjamin Graham’s big secret is not new. It is not complex, either. Intelligent investing in net net stocks is about patience, not speculation. The concept is simple: buy stable, conservatively financed, companies at absurdly cheap prices relative to value. With net nets, this value comes down to liquidation value, or what Ben Graham called “net current asset value”. Graham supplied the investment strategy years ago, it’s up to you to bring patience and execution.

I put money in the stock market around the crash of 2008, and like most people, most of it vanished. Would those stocks have done better if the whole economy wasn’t collapsing?

Maybe.

But, looking back, profit was not at all certain. I picked stocks based on speculation and the foolish assumption that if a stock is rising, it will continue to do so. This is the opposite of intelligent investing -- the smart investors are ready to move out when fools like me are moving in. Guess who is left holding the empty bag?

I had no idea what I wanted to do with my money. It was just sitting in my account barely earning any interest. I just wanted to dump it somewhere and be done with it. After I read everything I was told to read, I really understood what I had to do. I learned the skills it takes to invest money intelligently.

Before joining Net Net Hunter, I always made the mistake of thinking too short-term. Every point I lost or made mattered. I could feel my heart beat faster every time I looked at my portfolio. It was like looking up at the terrifying roller coaster and waiting for my turn to ride. Sure, some people came out smiling and jumped in line again, but when it was my turn to ride, they just slapped me in the face and kicked me out.

Do not think like a day trader. I don’t have the time or resources to profit from minor fluctuations in the market  -- and neither do you.  Enjoy the ride, but be emotionally detached from it.

How Value Investing Set My Portfolio Straight

How do you use Benjamin Graham’s net net stock strategy?

The first thing to understand is that an international scope and focus on high quality investment opportunities makes for solid investment returns. On the other hand, mediocre net net picks will make for mediocre results. With net net stocks, the odds of profit are in your favour but you want to filter through the muck available to get to those few high octane net net stocks.

When you think you found an opportunity, it’s time to break out the calculator. Compare the firm’s net current asset value per share to its current share price. If it is trading well under its value per share, you have a strong candidate. To figure out if it’s worth a spot in your portfolio, I run through Evan’s Core7 Scorecard next.

Buy low. Sell high. Sound familiar?

If a company is cheap relative to its value, and scores high based on Evan’s Core7 Scorecard, you buy it. When the stock price rises back up to net current asset value, you sell it and move on to the next one. The math does most of the decision making for you, not news or your gut. It may take a month, a year, or three years, but these companies produce super returns.

Patience has definitely been the most valuable skill I internalized throughout my reading and understanding of Benjamin Graham’s net net stock strategy. If I had of continued investing like I started out, I would be very broke by now. Banking everything on the belief that you can ride a rising market to quick profit is a terrible strategy for any investor.

Look for high quality net net stocks and do some research on them. If a net net stock qualifies based on sound criteria, buy a bit of it. Most net net strategists will tell you not to buy unless its NCAV is under 66.67% of its book value. Demanding at least this much of a discount what Graham found to be the sweet spot for sweet returns. If the stock rises up past that 1/3rd discount reevaluate and get ready to sell once net current asset value is reached.

If it is in the sweet spot, it is as good of a time as any to get in there and build your portfolio. I like to use limit orders so I can avoid a major price jump that could occure when placing a market order, and I might get a deeper discount. Net nets are usually illiquid stocks, which means that there is often a large gap between the “ask” price and the “bid” price. If you buy using market orders, as if you were trying to buy a share of Home Depot, you could easily pay 25% above your intended purchase price. Limit orders ensure you buy at your desired purchase price.

But, you can’t be too picky. If set too low, you might miss the chance to maximize profits. For example: Stock ABC is currently trading at $1.50 and has been fluctuating a bit over the last week then I might set the limit to buy at $1.40. If I want to get in there as soon as possible, I’d set my limit purchase price a little tighter at $1.45. Once it is bought, I make a note of it, record the price I want to sell if for based on its existing net current asset value, and leave it alone.

Three Paths When Value Investing

There are three scenarios from here.

  1. The stock never goes anywhere. Let your stock do its thing for up to three years. It takes fortitude to hold it for that long but, if it doesn’t reach back up to net current asset value in 3 years, cut your losses and move on. Holding on past 3 years is like hanging onto a relationship that isn’t going anywhere, expecting more.
  2. The stock goes down. Most people will panic and sell when their stock takes a tumble. Don’t do that! A drop in price is actually a good thing. These stocks are chosen for their discount to net current asset value, remember. A few of my stocks have dipped quite low, but I felt confident, so ended up investing more. Conservatively financed companies with bad news are the bread and butter of this strategy. You should know why it dipped, but this is your chance to -- you guessed it --  buy low and sell high. Doing so will decrease your cost per share and boost your eventual profits. Awesome, right?
  3. Your stock goes up. Excellent. Don’t buy anymore! Your cost per share will increase and your profits will decrease. Oh no! Let it ride to its net current asset value per share and sell it. Congratulations, and enjoy your profit.

I hope I painted a good picture of what you can expect from net net stocks. Benjamin Graham’s secret has been keeping intelligent investors profitable for years. There are many “systems” out there, but this one really speaks to the frugal guy that I am.

If you are okay doing a little research and staying patient, you can make satisfying returns on your smart investment. Start by downloading our Net Net Hunter Scorecard from Net Net Hunter. 

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