Someone who reads my articles asked me this question:
Regarding the newsletter that you edit the majority of the net-net you are recommending have a very small volume which makes it very hard for someone to purchase.
What would be the best way for a well-capitalized investor — with over $1 million in equity — to participate in a net-net strategy?
The honest answer — but not the one you want to hear — is that even if you have over $1 million to invest in net-nets, the best strategy is to buy pretty much the same stocks we've been recommending. The difference is that you may want to be buying everything we've recommended up to this point each month. Have bids out around the level we picked the stocks at for all 14 or so stocks we've picked so far. If the stock has fallen since we picked it you can just put in a bid at today’s trade price. If the stock falls further, you will get shares. If it rises, you may miss out.
For stocks that have risen in value since we picked them, I’d still put in GTC orders for them. I just wouldn’t use today’s last trade price. I’d use the price the stock was at when we originally picked it in the newsletter. In this way, whatever shares you do get will always be bought at prices equal to or lesser than the Ben Graham Net-Net Newsletter’s model portfolio got its shares at.
A bigger investor — which we’ll define as someone who wants to put millions of dollars, not thousands of dollars — into net-nets really has to spend more time buying the net-nets.
Instead of thinking about buying one net-net at a time, you need a buy list. Basically, whenever a stock on that list trades below the price you pencil in for it — you buy. You buy whatever shares you can. Now, because you are a constant buyer in that situation I would probably take a break from bidding every once in a while just to let the stock come down if that’s what others would let it do without your presence.
So, if you had a list with 14 picks on it, you might be out there trying to buy only those that are at or below the price they traded at when they were picked by the newsletter.
Let’s take a look at the Ben Graham Net-Net Newsletter’s past picks and see what this would mean.
I’m using data from when we published the latest issue of the Ben Graham: Net-Net Newsletter last Friday.
I’ve picked 14 stocks for the Ben Graham: Net-Net Newsletter’s model portfolio. Of those 14 stocks, 9 are now trading at or below where we picked them. So, you can go ahead and buy all 9 of those today.
How should you do it?
I would split that group of nine stocks into two smaller groups. So, maybe a group of four stocks and a group of five stocks. I’d bid for the first group of stocks in the first half of each month. And I’d bid for the second group of stocks in the second half of each month. This is just to ensure that you allow some trades to go through with somebody other than you buying. This can help avoid having you set a hard, steady floor for a stock.
As long as the price of any of the 14 stocks we’ve picked is below where we picked it I’d put in a good-till-canceled limit order for the maximum volume you are willing to buy at today’s last trade price. When I say today’s last trade price, I don’t mean to imply the stock last traded today. I just want to make it clear you shouldn’t – and this is obvious I know – bid what we bid back three or four months ago if the stock has fallen since then. There’s no reason to bid the maximum amount you are willing to pay for a stock. Instead, always bid the lower of the maximum you’d be willing to pay for a stock (for example, the price at which the newsletter picked the stock) or the last trade price.
And then I’d just keep that GTC order out for two weeks. Then I’d switch which group I was bidding for. And I’d switch on and off like that just so I wasn’t constantly bidding the same price for the stocks and not letting anyone else get in there.
This is a good idea if you plan to buy a stock constantly for months. It’s not necessary if you are focused on one stock and could plausibly get all the shares you want it in a couple big trades. I’m suggesting bidding for a couple weeks then taking a rest then bidding again only for investors who have a large amount to invest relative to the volume of that stock that trades in a given month.
For the vast majority of investors — even in illiquid stocks — it makes sense to always simply bid for the entire quantity you want at once. This is important in illiquid stocks because they may not trade for Monday through Thursday and then trade an average month’s worth of volume just on Friday morning. That happens. And obviously you want to be there getting your order filled when it happens.
But if you really are trying to stick $100,000 into a $3 million market cap stock or $1 million into a $30 million market cap stock — and so on — it’s okay to bid and then take a break. You can randomize it if you want. But I wouldn’t keep buying and buying if I knew I’d be getting the stock in little dribbles for months and months — because I’d worry that without taking a break from my bidding I’d really be bidding against myself by not letting the stock decline if there really are a lot of sellers and no buyers but me.
I wouldn’t give the trading any more thought than that. You can get very cute and complicated with all this. And traders probably should. Be if you’re an investor, I’d focus on picking what to buy — not how to buy it.
So, using our example of 9 stocks out of the 14 stocks you can buy using the list of just stocks that are below the price where the Ben Graham: Net-Net Newsletter picked them, you’d be bidding for the equivalent of 9 stocks for at least 10 trading days a month. This is because there are usually about five trading days a week and four weeks in a month and you’d be bidding for each stock only half the time. So, that’s 10 days of bidding for each stock each month.
The very least liquid stock we picked for the Ben Graham: Net-Net Newsletter — and this stock is far, far, far less liquid than the vast majority of picks — trades about $50,000 worth of stock in an average month. Even if you were not bidding for the stock half the time, that would leave $25,000 of volume.
It’s certainly fine to buy 20% of a stock’s volume. So, even in our smallest stock – with you only bidding half the time — we’re still talking about you being able to put more than $5,000 a month on average into that stock with very little effort — just some patience.
The reality is that in almost every stock in almost every month, you could put much, much more than $5,000 into the stock. Even in our smallest stock, you’d probably have no trouble getting $10,000 to $15,000 worth of the stock on an average month even if you didn’t bid for shares on every day of the month.
That’s an average month. Not every month. You’ll go for a month or two and getting nothing in some stocks. It can happen.
In my personal experience, there have been months where I got zero shares of some stock I was trying to buy. But I have never tried to put as little as $30,000 into a stock and failed to get all $30,000 into the stock within three months (if I started by bidding the stock’s last trade price). That’s literally never happened to me. I’ve never bid for a stock and failed to average putting at least $10,000 a month into it. And I’ve bid for some super illiquid stocks.
Again, I’ve put zero dollars into something in a particular month despite my best efforts. But that’s really not what matters. What matters is if you bid month after month for six months and you can’t get $60,000 worth of the stock. That’s when I would say, yes, in that situation you really did fail to put $10,000 a month into the stock.
So, in practice, if you keep bidding for shares in the same company over a matter of months it is much easier than you may suspect to put at least $10,000 a month into that stock. If you are bidding for six months to a year we are talking about $60,000 to $120,000 being perfectly possible in even some super illiquid stocks.
And that’s one stock. You’re not going to own just one net-net.
Trust me. I’ve put more than $100,000 into a single stock people told me was utterly ungettable. And, I actually did it at slightly less than the price the stock traded at before I started buying. (Again, this is because I let some small volume trades pass through without bidding for them.)
We could do a lot of math here. But I’ll make it simple. There are nine stocks that were picked by the Ben Graham Net-Net Newsletter at higher prices than they trade for today. In virtually every situation, you will – in an average month – be able to buy at least $15,000 worth of each of these stocks.
Therefore, you can put nine times $15,000 or $135,000 to work in net-nets starting this month. If you had $1 million to put into net-nets, it would take less than eight months to own $1 million worth of net-net at that monthly rate.
And that monthly rate is extremely doable.
Do I really mean to say that it could take you eight months to build a net-net portfolio if we’re talking a portfolio of $1 million or more?
Yes. That’s true. But it’s a one-time delay. Not many people have an extra $100,000 flowing into their brokerage account each month from now until the end of time. Once you have a list of a dozen or so net-nets you want to buy and you either spend time researching new net-nets for the list yourself or you use the Ben Graham: Net-Net Newsletter from now on — you’ll keep having enough options to put let’s say $100,000 a month into net-nets.
That’s by no means an aggressive estimate. It’s not difficult to buy $100,000 worth of net-nets in a month. It is sometimes almost impossible to buy $100,000 of a single net-net (it depends on the net-net) in a month.
So, you have to rethink the way you trade. The way you build up your portfolio. For liquid stocks people think about adding one stock at a time.
For net-nets, you have to think more like a fund. You have to think there are maybe 5 or 10 or 20 things we are bidding on today. Most are not new positions for us. But we are adding to them and we are sopping up the cash we’ve got.
It’s still investing. It’s just a slightly different way of executing the actual buying and selling of shares than most individual investors are used to doing.
But with online brokers and GTC orders, it’s really easy to implement something like this. It takes only a little bit of your time once or twice a month to check what you should be bidding for, adjust some prices, etc.
Even if you have $1 million to invest in net-nets, you’ll be able to buy all the net-nets you want within a year.
So, it’s really patience that you need instead of bigger net-nets.
I’m sure this sounds crazy to some people. And the truth is that if you are turned off by how you might have to buy these things — don’t invest in net-nets. If the idea that it can take months to buy something sours you on the whole thing, this really isn’t the area for you to be investing in. Stick to liquid stocks. Stick to stocks with a market cap of let’s say $100 million or more. Most stock specific liquidity issues really occur below that line. As long as you stay above $100 million in market cap, buying stocks is extremely easy in the modern world.
It used to be harder. For most of Ben Graham’s career — everything after 1929 — it was really, really hard compared to today. Remember, volume was low and stayed low after the crash.
But buying over the counter stocks, illiquid stocks, etc., is not some strange and recent pastime practiced by a few folks on the internet. It’s not just the folks who write Oddball Stocks, Whopper Investments, Interactive Investor Blog, and me here at GuruFocus.
This is something that Ben Graham did. It’s something Warren Buffett did when he was investing for himself and for the partnership. In fact, Buffett has mentioned investing in a stock in the 1950s which on an inflation adjusted basis is still much, much smaller than any stock I’ve ever bought.
I will make a confession. I have not yet had the pleasure of buying a stock with a market cap much below $2 million.
When you get that low market cap isn’t that important actually. It’s how the shares are spread around. Buffett also bought shares in a much bigger company for his partnership and he mentions that it probably traded just two times a month.
So the next time you think a stock is too illiquid for you — an individual investor — just think about Warren Buffett running an investment partnership and trying to buy a stock that averaged two trades a month.
For more on Warren Buffett’s early adventures in illiquid stocks see my article How Warren Buffett Made His First $100,000. Or read "The Snowball."
Anyway, if you look at how Warren Buffett invested, Ben Graham invested, Walter Schloss invested, etc., you’ll see the big difference was that unlike individual investors they had to buy for longer and sell for longer than we do.
It’s really arguable how much of a difference this makes. First of all, everybody sells net-nets too soon. And most people buy them too soon. So being slowed down on both ends certainly doesn’t look like it would hurt.
Like a lot of value strategies, momentum tends to help when added to a net-net screen. Since I don’t pay attention to momentum, I tend to see the net-nets I buy fall for a little while before they begin their slow ascent.
A little while is sometimes not a short time. We may be talking three months or one year. We’re not talking three years. I can’t be much more specific than that.
This is just my own experience.
I’d say the general tendency is much more toward three months than one year. But, I’d also say that in all the time I’ve been buying net-nets if I were to sell the net-nets I bought after just three months – my performance would be bad. It would not be market beating. It would probably significant lag the averages. Net-nets are not something you hold for two to four months. They will work better if you hold them for more like two to four years.
I’ve talked about backtests where you flip net-nets every year — but that’s really just a matter of convenience of what’s easy to back test. It is not based on some idea that one year is the best holding time for a net-net. As I’ve pointed out before, probably half of all net-nets will still be net-nets within one year. And probably one-fourth of net-nets will still be net-nets after two years.
I think of that as meaning you ought to hold your net-nets for a couple years if you want things to play out. Some will be resolved for better or worse in a matter of months. But if you want to make sure a majority of your net-nets are held long enough for them either to recover or fail in some way that proves or disproves you original investment thesis – I’d say we’re talking two years.
So my advice to anyone who wants to put a good chunk of money into net-nets — and let’s face it, that’s a really small audience — is to try to have a plan (a program) for placing trades that will allow you to put at least $100,000 a month into net-nets. If you are patient that will allow you to have a nice-sized portfolio spread across a bunch of different net-nets in a reasonable amount of time.
Now, I know I didn’t answer that question with what you probably wanted to hear. You probably wanted to know what the biggest net-nets are?
Okay. But one caveat. Big net-nets are often bad net-nets. I know a lot of people think micro-cap stocks do best because of their potential for huge growth, or the fact they were only micro caps because they were very near bankruptcy, or some other reason that posits that micro caps are not just more mispriced than other stocks.
Personally, I believe there is a very real tendency for the very smallest stocks to be more strangely priced than big stocks. Not always undervalued. But strangely valued. I think this is particularly noticeable under $100 million. That’s just a round number to use. Many of the best bargains are below $50 million.
When you find a $500 million market cap net-net — I’m not saying you should run, but...
You should be more alert. Really big net-nets rarely go unnoticed. It’s not some quirk of the way they are controlled, how hard the shares are to trade, etc., that is causing them to be a net-net.
There are just more interested buyers in a $500 million net-net. The net-net strategy is not a secret. And plenty of funds can put at least a little piece of their portfolio into a $500 million stock. So why isn’t every value fund in America scooping up a genuine net-net?
I’m not a big believer in knowing why a stock is so cheap. I don’t think it matters. A lot of people disagree with me. But I believe in the strong form of the Mr. Market metaphor. The market is there to serve you, not instruct you. You don’t learn from prices, you just take them or leave them and the rest of the time you pretend there is no stock market.
Having said that, I want to warn you that you need to pay special attention to the risk of catastrophic loss in a big net-net. Look at the F-Score. Look at the risk of obsolescence. Look at the amount of total liabilities. Look at whether they’ve historically been profitable or not. Look at whether or not they’ve had positive operating income and free cash flow these last 12 months.
You should do all these things — and more — when analyzing any net-net. But you definitely need to do them when looking at really big net-nets. Because the reason a really big stock is a net-net is often going to be because a lot of folks think it’s going to zero. And they are not necessarily wrong.
This is less true of some smaller net-nets. Sometimes people think small net-nets are just hopeless, family-controlled businesses with no catalyst doomed to exist in some kind of investment purgatory. It’s not a pleasant picture. But it beats bankruptcy.
Big net-nets are more of a coin flip situation. Some people think they’ll survive and make the folks who buy the stock today very, very rich. Others think they are headed for bankruptcy.
So here are some of the biggest net-nets around right now:
1. Steel Excel (SXCL)
2. FormFactor (NASDAQ:FORM)
3. Imation (NYSE:IMN)
4. Tuesday Morning (NASDAQ:TUES)
5. Pacific Biosciences (PACB)
6. Maxygen (MAXY)
7. Westell (WSTL)
8. Volt Information Sciences (VISI)
9. Yasheng Group (YHGG)
I don’t love that list. I like the 14 past picks in the Ben Graham Net-Net Newsletter’s model portfolio much better. The newsletter only owns 1 of those 9 net-nets. Remember, we have 9 net-nets out of the 14 picked for the newsletter that are trading below where we picked them. So, obviously I like those 9 net-nets a lot better than these 9 net-nets.
Like I said, I wouldn’t encourage you to buy those nine net-nets shown here — even if you’re looking to put a lot of money into net-nets. Instead you should look at your favorite net-nets — or the net-nets in the Ben Graham: Net-Net Newsletter — and use them as a buy list you are constantly placing orders from month after month.
Building a diversified collection of net-net through many months of purchasing is a better way to invest a lot of money in net-nets than trying to focus on the biggest net-nets.
Read Geoff’s Other Articles
Ask Geoff a Question
Check out the Buffett/Munger: Bargain Newsletter
Check out the Ben Graham: Net-Net Newsletter
Someone who reads my articles asked me this question: