When the last decent net net appears is that the end of the bull?, Mike posited.
I think Mike would agree with me on this one. Let me express it this way. The fact that net-nets exist now tells me that there are two markets. It makes me think of the movie Titanic. There are the vast majority of stocks up there in first class, and then there are these precious few (I can count them on my fingers today) down in third class. (If you've seen the movie, you know that the fun party was with the Irish guys in third class.) And even if you missed the movie, you know where the ship is now, so I think you all know where I'm going with this metaphor... The only difference is that I think on this doomed ship third class will be the ones who get the lifeboats. The guys in the internet stocks are going to be the ones begging from behind the iron bars as the last lifeboat leaves.
The HYDEAs of this world are extremely rare. I can find one of them every 8 months or so, and I am looking hard. Not just for net nets, but for either extreme net nets (greater than a 40% margin of safety) or ones with a catalyst). I look at every net-net I hear of or discover in a screen and reject 90% of them. After selling HYDE yesterday I looked back on the last three years and was pleased to discover that I have never made less than 40% within a year on one of these. It normally takes six months. The problem is that they are so rare. If I could find ten HYDEAs I would be investing on margin, rather than 60% in cash. I can't, though.
Since these companies are so small, they are below the radar screen of all but a handful of institutional investors. Therefore, I do not believe they have anything to do with market valuation. In my experience, they do not drop even when the market takes a big hit. I think I remember HYDEA not doing anything when the market dropped 550 points last October. Microcap net-nets I see as a way to test my stockpicking ability in what I believe is a market with the odds stacked impossibly against me.
I am working on another microcap net-net which I will post in a couple days. Just need to check a few more things out. I'll look forward to all of your comments.
Just remember, though, when Ben Graham did his writing, the net-nets he was talking about were companies you had heard of. If we could understand the market Ben Graham was seeing through our eyes today, he was seeing General Motors at 8, Intel at 15 and Caterpillar at 5. The market dropped 87% from a peak lower on P/E than the peak today. 87%! That means Caterpillar at 5. That is what is so tough about applying Graham's wisdom - he was not talking about microcaps in awful businesses at net-net valuations. He was talking about buying Caterpillar at net-net valuations. The thought process is completely relevant, but I have no doubt that Graham would be 90% in cash today.
[And for those newcomers wondering what a "net-net" is. A "net-net" is a cheapskate's (aka a real value investor's) dream, a stock trading at less than current assets minus all liabilities. In English, that means the business is free. You are paying for the company's cash and receivables and inventories and getting everything else (factories, brand name, real estate, sales contracts, etc.) for free. I refer you to Ben Graham's classic work, The Intelligent Investor, to learn more.]
- Jim |
