How To Get Explosive NCAV Stocks Return in 2015 by Evan Bleker, Net Net Hunter
It’s just not true that all NCAV stocks are created equally. While they work out great together as a group, some NCAV investments are way more promising than others.
A NCAV Investment Checklist?
Checklists have been tremendously valuable in all sorts of industries for reducing or eliminating human error. Pilots, for example, go through a list of things they need to check on an airplane before takeoff in order to reduce any factors that could lead to a devastating crash.
More recently, investors such as Monish Pabrai have incorporated checklists into their own investment process to make sure they don’t leave out any critical pieces of information when researching a stock. Warren Buffett and Charlie Munger are no different — though they call their checklist items “filters”.
While it’s just not possible to eliminate all human error, you can go a long way towards reducing your own mistakes by putting together a scorecard that you can use when assessing potential investments. Of course, you could use mine, as well.
Proof? Click Here to look at my brokerage statement for the first 10 months of 2014.
Building My NCAV Scorecard
I’ve spent a considerable amount of time combing through Benjamin Graham’s books, Warren Buffett’s partnership letters, and a number of different scientific studies that examined NCAV stocks. In the process, I’ve kept notes on the investment tactics that produce the highest possible returns using this strategy.
I’ve put those best practices together into an investment checklist that I’ve found invaluable when selecting NCAV stocks. Given my NCAV portfolio’s exceptional returns over the last 3 years, I’ve decided to update this checklist for 2014.
The checklist runs through critical elements that must be in place before I’ll even consider a stock before covering other key factors important in the selection process and eventually moving on to some of the qualitative facts that I look for.
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It’s important to remember that this checklist serves as a great first run through for any net net stock that you’re assessing but it doesn’t cover some of the qualitative aspects that separate the promising NCAV stocks from the ones that will see stratospheric returns. I don’t think any checklist can successfully cover those soft facts because recognizing these types of patterns takes significant experience in business and investing.
My NCAV Scorecard
This is the first set of criteria that I use. To me, this set of 7 criteria is black and white and can lead me to immediately exclude a company from being an investment candidate.
NCAV Core Criteria
Not Chinese – I won’t buy a net net stock of a company that is based in China or has major operations in China. Basically, I’m trying to avoid reverse takeover scams. While there are probably good Chinese net net stocks I just feel it’s better to avoid this group as a whole.
Low Price-to-NCAV – Less than 50%. The reality is that the the smaller the price to NCAV the better the returns will be as an average. The difference between a stock trading at 40% of it’s NCAV and one trading at 60% of its NCAV is striking. While the company trading at 60% of its NCAV only has to rise 66% to be fully valued on a net current asset value basis, the company trading at 40% needs to rise 125% to reach fair value. On top of that, the higher priced NCAV stock has a greater likelihood of falling further in price while the cheaper priced company can provide great returns even if it doesn’t reach full net current asset value.
Low Debt-to-Equity – The same reasoning works for debt-to-equity levels. If the company has too much debt, making for the spread between total liabilities and current assets too thin, then the company’s NCAV can easily be wiped out. Having a low debt-to-equity ratio means having a large margin of safety. I won’t invest in a company that has a debt-to-equity ratio of over 25%.
You should keep in mind that a key part of calculating a firm’s NCAV is taking into account any preferred shares that are part of the company’s capital structure, and the off balance sheet liabilities that the company is on the hook for. I don’t screen out companies that have unfunded pensions — which are a common source of off balance sheet liabilities — but I do make sure to include the unfunded pension in the company’s total liabilities section. You should do the same since this is an obligation the company has made which amounts to a debt. Unfortunately, unfunded pensions aren’t included as part of the balance sheet so you have to dig for the information.
Adequate Past Earnings or Catalyst – I want my companies to have shown an adequate record of earnings in the past. While I don’t spend a lot of time measuring net profit margins and comparing those margins to the company’s peers, a history of low profitability tends to produce perennial NCAV stocks, stocks that always seem to trade below their net current asset value. Barring suitable profitability, I’d like to see some obvious catalyst on the horizon that would lead to either improved business results or a meaningful rise in the stock price. For example, if management suddenly put the company up for sale then I would expect that the company could be sold for at least the value of its net current assets.
An adequate past record also means a fairly stable past record. How stable is stable? Tough to say. This is a qualitative figure but I can recognize a company with an unstable past record of earnings as I see it.
Past Price Above NCAV – While its true that the past price of a company is not a good predictor of the future price of the stock it can serve as a warning sign. To me, when a company’s stock has traded below NCAV for years it’s a big red flag. Typically, NCAV stocks tend to rise within 3 years because a firm buys the company, the company liquidates, or the company is able to solve the problem that pushed it deep below NCAV in the first place. If the stock has traded below NCAV for a good number of years than it’s a sign that management is having a tough time addressing the business issues they were facing and that their either unwilling or unable to sell the firm. Sometimes parasitic management is just complacent and content to suck back fat salaries while the business does nothing for investors.
Existing Operations or Liquidation – Another great way to burn your money is by buying companies that don’t have existing operations. This includes things like legal entities (corporations, LLCs, etc) sitting on a bank account but not much more, with only faint promises of future business operations or, more commonly, pharmaceutical research companies which always seem to burn through their working capital without much to show for it. In cases like these, you may never see your stock rise up to its NCAV. You could wait forever only to disappoint your grandchildren by leaving them