I have not proven this, but I believe I can improve on the net nets, by selecting the best of breed. I look for a good current ratio, some revenue, some earnings (rare), high insider ownership, a prediction of future growth, improving analyst sentiment, etc. Rarely do I find all of these.
I have not proven this, but I believe I can improve on the net nets, by selecting the best of breed. I look for a good current ratio, some revenue, some earnings (rare), high insider ownership, a prediction of future growth, improving analyst sentiment, etc. Rarely do I find all of these.
Since they’re not likely to all be present, do you have a ranking for the factors?
DB2
The biggest problem with a typical net-net is, I suspect, that the value is being eroded: value is falling, not rising.
The expectation of value destruction is the only rational reason a company should trade as a net-net.
So, the key goal is to try to filter those out as well as you can.
I would look first to something like a forward free cash flow yield estimate, if you could find it.
Or forward cash flow yield, or forward earnings yield, or current cash flow yield, or current earnings yield, whatever you could find.
A lot of these might be negative, but mildly negative is probably better than strongly negative, right?
I’d lean towards forward estimates if you can find them, since such firms often have high odds of material one-time things in any given reporting period.
But of course, hand filtering by looking too closely at MI picks is usually a bad idea–testing is better.
Remember Murphy’s law of quant investing: the stuff that looked worst probably generated the most returns in the backtest.
Having done business with a public net-net run by someone I knew, I can tell you why that one was a net-net.
Financial statements don’t tend to capture the hidden liability of management with (over) generous salaries and golden severance parachutes.
I knew the firm’s situation with some detail because of the work I was doing for them–managing their cash pile–but I didn’t buy any shares.
Even though the market value net asset value was a multiple of the stock price.
Jim
7 Likes
- good current ratio is essential
- earnings rare, but if exists is great.
- high insider ownership
- some revenue
You can also look at analyst reports at Fidelity about them.
I will add what Jim mentioned also.
1. good current ratio is essential
The problem is that it means very different things for different types of businesses.
For example, it’s perennially a low figure for Dell, but because of the nature of their business it isn’t a bad thing.
So you can run into the situation that it’s decidedly bad if it’s deteriorating, but not necessarily bad if it’s merely worse than for another company you’re looking at.
Jim
3 Likes
For this type of business. negative earnings, and no revenue, they will go bankrupt without a good current ratio.
For this type of business. negative earnings, and no revenue, they will go bankrupt without a good current ratio.
Sure…if all three are bad, something bad is bound to happen.
But your comment appeared to be about the centrality of current ratio.
Many very successful firms have seemingly terrible current ratios, for very good reasons.
It depends on the nature of the business in question.
Specifically, you said "1. good current ratio is essential "
My humble suggestion: No, it definitely isn’t.
Jim
2 Likes
I agree for most companies it is not, but for a company that has no revenue and negative earnings, it won’t be around long without a good current ratio.