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Net current asset value and net net working capital back-test refined

Posted in About, Liquidation Value, Net Current Asset Value, Net Quick Stocks, Net Quick Value, tagged , , , , , , on February 19, 2010| 2 Comments »

Jae Jun at Old School Value has updated his great post back-testing the performance of net current asset value (NCAV) against “net net working capital” (NNWC) by refining the back-test (see NCAV NNWC Backtest Refined). His new back-test increases the rebalancing period to 6 months from 4 weeks, excludes companies with daily volume below 30,000 shares, and introduces the 66% margin of safety to the NCAV stocks (I wasn’t aware that this was missing from yesterday’s back-test, and would explain why the performance of the NCAV stocks was so poor).

Jae Jun’s original back-test compared the performance of NCAV and NNWC stocks over the last three years. He calculated NNWC by discounting the current asset value of stocks in line with Graham’s liquidation value discounts, but excludes the “Fixed and miscellaneous assets” included by Graham. Here’s Jae Jun’s NNWC formula:

NNWC = Cash + (0.75 x Accounts receivables) + (0.5 x  Inventory)

Here’s Graham’s suggested discounts (extracted from Chapter XLIII of Security Analysis: The Classic 1934 Edition “Significance of the Current Asset Value”):

As I noted yesterday, excluding the “Fixed and miscellaneous assets” from the liquidating value calculation makes for an exceptionally austere valuation.

Jae Jun has refined his screening criteria as follows:

  • Volume is greater than 30k
  • NCAV margin of safety included
  • Slippage increased to 1%
  • Rebalance frequency changed to 6 months
  • Test period remains at 3 years

Here are Jae Jun’s back-test results with the new criteria:

For the period 2001 to 2004

For the period 2004 to 2007

For the period 2007 to 2010


It’s an impressive analysis by Jae Jun. Dividing the return into three periods is very helpful. While the returns overall are excellent, there were some serious smash-ups along the way, particularly the February 2007 to March 2009 period. As Klarman and Taleb have both discussed, it demonstrates that your starting date as an investor makes a big difference to your impression of the markets or whatever theory you use to invest. Compare, for example, the experiences of two different NCAV investors, one starting in February 2003 and the second starting in February 2007. The 2003 investor was up 500% in the first year, and had a good claim to possessing some investment genius. The 2007 investor was feeling very ill in March 2009, down around 75% and considering a career in truck driving. Both were following the same strategy, and so really had no basis for either conclusion. I doubt that thought consoles the trucker.

Jae Jun’s Old School Value NNWC NCAV Screen is available here (it’s free).

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Back-testing the performance of net current asset value against net net working value

Posted in About, Liquidation, Liquidation Value, Net Current Asset Value, Net Quick Stocks, Net Quick Value, Stocks, tagged , , , , , , , on February 18, 2010| 4 Comments »

Jae Jun at Old School Value has a great post, NCAV NNWC Screen Strategy Backtest, comparing the performance of net current asset value stocks (NCAV) and “net net working capital” (NNWC) stocks over the last three years. To arrive at NNWC, Jae Jun discounts the current asset value of stocks in line with Graham’s liquidation value discounts, but excludes the “Fixed and miscellaneous assets” included by Graham. Here’s Jae Jun’s NNWC formula:

NNWC = Cash + (0.75 x Accounts receivables) + (0.5 x  Inventory)

Here’s Graham’s suggested discounts (extracted from Chapter XLIII of Security Analysis: The Classic 1934 Edition “Significance of the Current Asset Value”):

Excluding the “Fixed and miscellaneous assets” from the NNWC calculation provides an austere valuation indeed (it makes Graham look like a pie-eyed optimist, which is saying something). The good news is that Jae Jun’s NNWC methodology seems to have performed exceptionally well over the period analyzed.

Jae Jun’s back-test methodology was to create two concentrated portfolios, one of 15 stocks and the other of 10 stocks. He rolled the positions on a four-weekly basis, which may be difficult to do in practice (as Aswath Damodaran pointed out yesterday, many a slip twixt cup and the lip renders a promising back-tested strategy useless in the real world). Here’s the performance of the 15 stock portfolio:

“NNWC Incr.” is “NNWC Increasing,” which Jae Jun describes as follows:

NNWC is positive and the latest NNWC has increased compared to the previous quarter. In this screen, NNWC doesn’t have to be less than current market price. Since the requirement is that NNWC is greater than 0, most large caps automatically fail to make the cut due to the large quantity of intangibles, goodwill and total debt.

Both the NNWC and NNWC Increasing portfolios delivered exceptional returns, up 228% and 183% respectively, while the S&P500 was off 26%. The performance of the NCAV portfolio was a surprise, eeking out just a 5% gain over the period, which is nothing to write home about, but still significantly better than the S&P500.

The 10 stock portfolio’s returns are simply astonishing:

Jae Jun writes:

An original $100 would have become

  • NCAV: $103
  • NNWC: $544
  • NNWC Incr: $503
  • S&P500: $74

That’s a gain of over 400% for NNWC stocks!

Amazing stuff. It would be interesting to see a full academic study on the performance of NNWC stocks, perhaps with holding periods in line with Oppenheimer’s Ben Graham’s Net Current Asset Values: A Performance Update for comparison. You can see Jae Jun’s Old School Value NNWC NCAV Screen here (it’s free). He’s also provided a list of the top 10 NNWC stocks and top 10 stocks with increasing NNWC in the NCAV NNWC Screen Strategy Backtest post.

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Walking the talk: Applying back-tested investment strategies in practice

Posted in About, Behavioral economics, Contrarian investment, Liquidation Value, Net Current Asset Value, Net Quick Stocks, Quantitative investment, Stocks, Value Investment, tagged , , , , , , , , on February 17, 2010| 10 Comments »

Aswath Damodaran, a Professor of Finance at the Stern School of Business, has an interesting post on his blog Musings on Markets, Transaction costs and beating the market. Damodaran’s thesis is that transaction costs – broadly defined to include brokerage commissions, spread and the “price impact” of trading (which I believe is an important issue for some strategies) – foil in the real world investment strategies that beat the market in back-tests. He argues that transaction costs are also the reason why the “average active portfolio manager” underperforms the index by about 1% to 1.5%. I agree with Damodaran. The long-term, successful practical application of any investment strategy is difficult, and is made more so by all of the frictional costs that the investor encounters. That said, I see no reason why a systematic application of some value-based investment strategies should not outperform the market even after taking into account those transaction costs and taxes. That’s a bold statement, and requires in support the production of equally extraordinary evidence, which I do not possess. Regardless, here’s my take on Damodaran’s article.

First, Damodaran makes the point that even well-researched, back-tested, market-beating strategies underperform in practice:

Most of these beat-the-market approaches, and especially the well researched ones, are backed up by evidence from back testing, where the approach is tried on historical data and found to deliver “excess returns”. Ergo, a money making strategy is born.. books are written.. mutual funds are created.

…

The average active portfolio manager, who I assume is the primary user of these can’t-miss strategies does not beat the market and delivers about 1-1.5% less than the index. That number has remained surprisingly stable over the last four decades and has persisted through bull and bear markets. Worse, this under performance cannot be attributed to “bad” portfolio mangers who drag the average down, since there is very little consistency in performance. Winners this year are just as likely to be losers next year…

Then he explains why he believes market-beating strategies that work on paper fail in the real world. The answer? Transaction costs:

So, why do portfolios that perform so well in back testing not deliver results in real time? The biggest culprit, in my view, is transactions costs, defined to include not only the commission and brokerage costs but two more significant costs – the spread between the bid price and the ask price and the price impact you have when you trade. The strategies that seem to do best on paper also expose you the most to these costs. Consider one simple example: Stocks that have lost the most of the previous year seem to generate much better returns over the following five years than stocks have done the best. This “loser” stock strategy was first listed in the academic literature in the mid-1980s and greeted as vindication by contrarians. Later analysis showed, though, that almost all of the excess returns from this strategy come from stocks that have dropped to below a dollar (the biggest losing stocks are often susceptible to this problem). The bid-ask spread on these stocks, as a percentage of the stock price, is huge (20-25%) and the illiquidity can also cause large price changes on trading – you push the price up as you buy and the price down as you sell. Removing these stocks from your portfolio eliminated almost all of the excess returns.

In support of his thesis, Damodaran gives the example of Value Line and its mutual funds:

In perhaps the most telling example of slips between the cup and lip, Value Line, the data and investment services firm, got great press when Fischer Black, noted academic and believer in efficient markets, did a study where he indicated that buying stocks ranked 1 in the Value Line timeliness indicator would beat the market. Value Line, believing its own hype, decided to start mutual funds that would invest in its best ranking stocks. During the years that the funds have been in existence, the actual funds have underperformed the Value Line hypothetical fund (which is what it uses for its graphs) significantly.

Damodaran’s argument is particularly interesting to me in the context of my recent series of posts on quantitative value investing. For those new to the site, my argument is that a systematic application of the deep value methodologies like Benjamin Graham’s liquidation strategy (for example, as applied in Oppenheimer’s Ben Graham’s Net Current Asset Values: A Performance Update) or a low price-to-book strategy (as described in Lakonishok, Shleifer, and Vishny’s Contrarian Investment, Extrapolation and Risk) can lead to exceptional long-term investment returns in a fund.

When Damodaran refers to “the price impact you have when you trade” he highlights a very important reason why a strategy in practice will underperform its theoretical results. As I noted in my conclusion to Intuition and the quantitative value investor:

The challenge is making the sample mean (the portfolio return) match the population mean (the screen). As we will see, the real world application of the quantitative approach is not as straight-forward as we might initially expect because the act of buying (selling) interferes with the model.

A strategy in practice will underperform its theoretical results for two reasons:

  1. The strategy in back test doesn’t have to deal with what I call the “friction” it encounters in the real world. I define “friction” as brokerage, spread and tax, all of which take a mighty bite out of performance. These are two of Damodaran’s transaction costs and another – tax. Arguably spread is the most difficult to prospectively factor into a model. One can account for brokerage and tax in the model, but spread is always going to be unknowable before the event.
  2. The act of buying or selling interferes with the market (I think it’s a Schrodinger’s cat-like paradox, but then I don’t understand quantum superpositions). This is best illustrated at the micro end of the market. Those of us who traffic in the Graham sub-liquidation value boat trash learn to live with wide spreads and a lack of liquidity. We use limit orders and sit on the bid (ask) until we get filled. No-one is buying (selling) “at the market,” because, for the most part, there ain’t no market until we get on the bid (ask). When we do manage to consummate a transaction, we’re affecting the price. We’re doing our little part to return it to its underlying value, such is the wonderful phenomenon of value investing mean reversion in action. The back-test / paper-traded strategy doesn’t have to account for the effect its own buying or selling has on the market, and so should perform better in theory than it does in practice.

If ever the real-world application of an investment strategy should underperform its theoretical results, Graham liquidation value is where I would expect it to happen. The wide spreads and lack of liquidity mean that even a small, individual investor will likely underperform the back-test results. Note, however, that it does not necessarily follow that the Graham liquidation value strategy will underperform the market, just the model. I continue to believe that a systematic application of Graham’s strategy will beat the market in practice.

I have one small quibble with Damodaran’s otherwise well-argued piece. He writes:

The average active portfolio manager, who I assume is the primary user of these can’t-miss strategies does not beat the market and delivers about 1-1.5% less than the index.

There’s a little rhetorical sleight of hand in this statement (which I’m guilty of on occasion in my haste to get a post finished). Evidence that the “average active portfolio manager” does not beat the market is not evidence that these strategies don’t beat the market in practice. I’d argue that the “average active portfolio manager” is not using these strategies. I don’t really know what they’re doing, but I’d guess the institutional imperative calls for them to hug the index and over- or under-weight particular industries, sectors or companies on the basis of a story (“Green is the new black,” “China will consume us back to the boom,” “house prices never go down,” “the new dot com economy will destroy the old bricks-and-mortar economy” etc). Yes, most portfolio managers underperform the index in the order of 1% to 1.5%, but I think they do so because they are, in essence, buying the index and extracting from the index’s performance their own fees and other transaction costs. They are not using the various strategies identified in the academic or popular literature. That small point aside, I think the remainder of the article is excellent.

In conclusion, I agree with Damodaran’s thesis that transaction costs in the form of brokerage commissions, spread and the “price impact” of trading make many apparently successful back-tested strategies unusable in the real world. I believe that the results of any strategy’s application in practice will underperform its theoretical results because of friction and the paradox of Schrodinger’s cat’s brokerage account. That said, I still see no reason why a systematic application of Graham’s liquidation value strategy or LSV’s low price-to-book value strategy can’t outperform the market even after taking into account these frictional costs and, in particular, wide spreads.

Hat tip to the Ox.

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Three ghosts of bear markets past, redux

Posted in About, Behavioral economics, Contrarian investment, Greenbackd, Net Current Asset Value, Stocks, tagged on February 16, 2010| 2 Comments »

Speculating about the level of the market is a pastime for fools and knaves, as I have amply demonstrated in the past (or, as Edgar Allen Poe would have it, “I have great faith in fools — self-confidence my friends will call it.”). In April last year I ran a post, Three ghosts of bear markets past, on DShort.com’s series of charts showing how the current bear market compared to three other bear markets: the Dow Crash of 1929 (1929-1932), the Oil Crisis (1973-1974) and the Tech Wreck (2000-2002). At that time the market was up 24.4% from its low, and I said,

Anyone who thinks that the bounce means that the current bear market is over would do well to study the behavior of bear markets past (quite aside from simply looking at the plethora of data about the economy in general, the cyclical nature of long-run corporate earnings and price-earnings multiples over the same cycle). They might find it a sobering experience.

Now the market is up almost 60% from its low, which just goes to show what little I know:

While none of us are actually investing with regard to the level of the market – we’re all analyzing individual securities – I still find it interesting to see how the present aggregate experience compares to the experience in other epochs in investing. One other chart by DShort.com worth seeing is the “Three Mega-Bears” chart, which treats the recent decline as part of the decline from the “Tech Wreck” on the basis that the peak pre-August 2007 did not exceed the peak pre-Tech Wreck after adjusting for inflation:

It’s interesting for me because it compares the Dow Crash of 1929 (from which Graham forged his “Net Net” strategy) to the present experience in the US and Japan (both of which offer the most Net-Net opportunities globally). Where are we going from here? Que sais-je? The one thing I do know is that 10 more years of a down or sideways market is, unfortunately, a real possibility.

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President’s Day

Posted in Greenbackd on February 15, 2010| Leave a Comment »

Have a good break. See you tomorrow.

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The Kabuki narrative

Posted in About, Behavioral economics, Liquidation, Liquidation Value, Net Current Asset Value, Net Quick Stocks, Net Quick Value, Stocks, tagged , , , , on February 12, 2010| 5 Comments »

Regular readers of Greenbackd know that I’m no fan of “the narrative,” which is the story an investor concocts to explain the various pieces of data the investor gathers about a potential investment. It’s something I’ve been thinking about a great deal recently as I grapple with the merits of an investment in Japanese net current asset value stocks. The two arguments for and against investing in such opportunities are as follows:

Fer it: Net current asset value stocks have performed remarkably well throughout the investing world and over time. In support of this argument I cite generally Graham’s experience, Oppenheimer’s Ben Graham’s Net Current Asset Values: A Performance Update paper, Testing Ben Graham’s Net Current Asset Value Strategy in London, a paper from the business school of the University of Salford in the UK, and, more specifically, Bildersee, Cheh and Zutshi’s The performance of Japanese common stocks in relation to their net current asset values, James Montier’s Graham’’s net-nets: outdated or outstanding?, and Dylan Grice’s Are Japanese equities worth more dead than alive.

Agin it: Japan is a special case because it has weak shareholder rights and a culture that regards corporations as “social institutions with a duty to provide stable employment and consider the needs of employees and the community at large, not just shareholders.” In support of this argument I cite the recent experiences of activist investors in Japan, and Bildersee, Cheh and Zutshi’s The performance of Japanese common stocks in relation to their net current asset values (yes, it supports both sides of the argument). Further, the prospects for Japan’s economy are poor due to its large government debt and ageing population.

How to break the deadlock? Montier provides a roadmap in his excellent Behavioural Investing:

We appear to use stories to help us reach decisions. In the ‘rational’ view of the world we observe the evidence, we then weigh the evidence, and finally we come to our decision. Of course, in the rational view we all collect the evidence in a well-behaved unbiased fashion. … Usually we are prone to only look for the information that happens to agree with us (confirmatory bias), etc.

However, the real world of behaviour is a long way from the rational viewpoint, and not just in the realm of information gathering. The second stage of the rational decision is weighing the evidence. However, as the diagram below shows, a more commonly encountered approach is to construct a narrative to explain the evidence that has been gathered (the story model of thinking).

Hastie and Pennington (2000) are the leading advocates of the story view (also known as explanation-based decision-making). The central hypothesis of the explanation-based view is that the decision maker constructs a summary story of the evidence and then uses this story, rather than the original raw evidence, to make their final decision.

…

All too often investors are sucked into plausible sounding story. Indeed, underlying some of the most noted bubbles in history are kernels of truth.

As to the last point, arguably, the converse is also true. Investors have missed some great returns because the ugly stories about companies or markets were so compelling.

There are several points that are not contentious about an investment in Japan. The data suggests to me and to everyone else that there are a large number of net current asset value bargains available there. The contention is whether these net current asset value stocks will perform as they have in other countries, or whether they are destined to remain net current asset value bargains, the classic “value traps.” My own penchant for value investing, and quantitative value investing in particular, makes this a reasonably simple matter to resolve. I am going to invest in Japanese net current asset value stocks. Here are the bases for my reasoning:

  • I believe that value investing works. I believe that this is the case because it appeals to me as a matter of logic. I also believe that the data supports this position (see Ben Graham’s Net Current Asset Values: A Performance Update or Lakonishok, Shleifer, and Vishny’s Contrarian Investment, Extrapolation and Risk). Where a stock trades at a significant discount to its value, I am going to take a position.
  • I believe that Graham’s net current asset value works. In support of this proposition I cite the papers listed in the “Fer it” argument above.
  • I believe that simple quantitative models consistently outperform expert judgements. In support of this proposition generally I cite James Montier’s Painting By Numbers: An Ode To Quant. Where the data looks favorable to me, I am going to take a position, and I’m going to ignore the qualitative factors.
  • I believe that value is a good predictor of returns at a market level. In support I cite the Dimson, Marsh and Staunton research. I am not dissuaded from investing in a country simply because its growth prospects are low. Value is the signal predictor of returns.

The arguments militating against investing in Japan sound to me like the arguments militating against any investment in a NCAV stock, which is to say that they are arguments rooted in the narrative. I’ve never taken a position in a NCAV stock that had a good story attached to it. They have always looked ugly from an earnings or narrative perspective (otherwise, they’d be trading at a higher price). As far as I can tell, this situation is no different, other than the fact that it is in a different country and the country has economic problems (which I would ignore in the usual case anyway). While the research specific to NCAV stocks in Japan is not as compelling as I would like it to be, I always bear in mind the lessons of Taleb’s “naive empiricist,” which is to say that the data are useful only up to a point.

This is not to say that I have any great conviction about Japan or Japanese net current asset value stocks. Far from it. I fully expect, as I always do when taking a position in any stock, to be wrong and have the situation follow the narrative. Fortunately, the decision is out of my hands. I’m going to follow my simple quantitative model – the Graham net current asset value strategy – and take some positions in Japanese net nets. The rest is for the goddess Fortuna.

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Activist investing in Japan

Posted in About, Activist Investors, Liquidation, Liquidation Value, Steel Partners, Stocks, tagged , on February 11, 2010| 4 Comments »

Central to the discussion of sub-liquidation value investing in Japan is the ability or willingness of shareholders to influence management, and management’s willingness to listen. As Ben Graham noted in the 1934 edition of Security Analysis, in the US:

The whole issue may be summarized in the form of a basic principle, viz:

When a common stocks sells persistently below its liquidating value, then either the price is too low, or the company should be liquidated. Two corollaries may be deduced from this principle:

Corollary I. Such a price should impel the stockholders to raise the question whether it is in their interest to continue the business.

Corollary II. Such a price should impel the management to take all proper steps to correct the obvious disparity between market quotation and intrinsic value, including a reconsideration of its own policies and a frank justification to the stockholders of its decision to continue the business.

The perception is that, in Japan, these two corollaries do not flow from that basic principle. As The Economist notes in a February 2008 article, Samurai v shareholders: Japan’s establishment continues to rebuff foreign activist investors (subscription required):

Japanese businessmen and politicians fear that the activists are short-term investors keen to strip firms of their cash. The conflict highlights a fundamental divide: companies in Japan are social institutions with a duty to provide stable employment and consider the needs of employees and the community at large, not just shareholders.

And therein lies the rub. Companies in Japan are social institutions with a duty to provide stable employment and consider the needs of employees and the community at large, not just shareholders.

Can foreign investors not subject to the cultural expectation that companies consider the needs of employees and the community at large succeed?

According to a 2009 Knowledge@Wharton article, How the Environment for Foreign Direct Investment in Japan Is Changing — for the Better, the environment for foreign investors in Japan is improving, but continues to be more bureaucratic than in the US:

Despite the support shown by elected officials for increasing [foreign direct investment] in Japan, foreign investors still face a substantial amount of bureaucratic red tape, particularly with respect to protected industries. [Direct investment] is principally governed by the Foreign Exchange and Foreign Trade Control Law, which specifically prevents foreign investors from acquiring a majority stake in Japanese companies within industry sectors classified as closely related to national security and public safety. This includes industries as diverse as aeronautics, defense, nuclear power generation, energy, telecom, broadcasting, railways, tourist transportation, petroleum and leather processing.

Foreign investors intending to make direct investments in certain industries must file with the Japanese Ministry of Finance as well as the respective ministry governing the specific industry of the investment target. If issues are found in relation to the investment, either the Ministry of Finance or the industry-specific ministry has the authority to issue an official recommendation to revise the investment plan or to put a complete stop to the acquisition. Industry-specific regulations that, for example, limit foreign ownership to one-third for airline and telecom companies, further constrain foreign investors.

It’s worth considering the experience of two notable activist campaigns in Japan. The first, Steel Partners’ campaign for Sapporo, the brewer, is described in the Knowledge@Wharton article:

Steel Partners has imported its U.S. activist investment model to Japan and has shown a willingness to question publicly the strategy of current management at its investment targets and to litigate disagreements.

As a result of Steel Partners’ posture, the firm’s take-over bid for household-brand Bulldog Sauce met with resistance from the media and Japan’s legal system. The court to which Steel Partners appealed a failed injunction to prevent Bulldog’s poison-pill strategy stated: “[Steel Partners] pursues its own interests exclusively and seeks only to secure profits by selling companies’ shares back to the company or to third parties in the short term, in some cases with an eye to disposing of company assets…. As such, it is proper to consider the plaintiff an abusive acquirer.”

The Economist article discusses the The Children’s Investment Fund’s (TCI) battle for the Japanese power provider J-Power:

The biggest showdown between the activists and the establishment is at J-Power, the former state-run energy firm, which was privatised in 2004. [TCI] a British fund, which owns 9.9% of the firm, has been politely but firmly lobbying J-Power to appoint two TCI representatives to its board, improve margins and unwind cross-shareholdings with other firms. Having been rebuffed, TCI now wants to double its bet. In January it asked for permission to increase its stake to 20% (any holding above 10% requires government approval). John Ho, the head of TCI’s Asian operations, says the deal is a test of the integrity of Japan’s reform agenda. And it would be, except that Mr Ho has chosen a remarkably hard case. Japan, lacking natural resources, is worried about energy security and is reluctant to hand more control over its power infrastructure to foreign investors.

The Knowledge@Wharton article concludes:

After applying for approval to increase shareholdings to 20%, TCI met a wall of resistance: J-Power management cautioned that TCI could cut maintenance and investment costs in nuclear plants, and the Japanese media relayed sensationalist warnings about the potential for “blackouts.” The result: The Japanese government blocked the investment.

These are not encouraging outcomes. The final word is best left to Takao Kitabata, the vice-minister of Japan’s powerful Ministry of Economy, Trade and Industry (METI):

To be blunt, shareholders in general do not have the ability to run a company. They are fickle and irresponsible. They only take on a limited responsibility, but they greedily demand high dividend payments.

High dividend payments? We’re a long way from liquidation as a matter of course.

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5 big Japanese Graham net nets

Posted in About, Liquidation Value, Net Current Asset Value, Net Quick Stocks, Net Quick Value, Value Investment, tagged , , , , on February 10, 2010| 5 Comments »

In his Are Japanese equities worth more dead than alive?, SocGen’s Dylan Grice conducted some research into the performance of sub-liquidation value stocks in Japan since the mid 1990s. Grice’s findings are compelling:

My Factset backtest suggests such stocks trading below liquidation value have averaged a monthly return of 1.5% since the mid 1990s, compared to -0.2% for the Topix. There is no such thing as a toxic asset, only a toxic price. It may well be that these companies have no future, that they shouldn’t be valued as going concerns and that they are worth more dead than alive. If so, they are already trading at a value lower than would be fetched in a fire sale. But what if the outlook isn’t so gloomy? If these assets aren’t actually complete duds, we could be looking at some real bargains…

In the same article, Grice identifies five Graham net net stocks in Japan with market capitalizations bigger than $1B:

He argues that such stocks may offer value beyond the net current asset value:

The following chart shows the debt to shareholders equity ratios for each of the stocks highlighted as a liquidation candidate above, rebased so that the last year’s number equals 100. It’s clear that these companies have been aggressively delivering in the last decade.

Despite the “Japan has weak shareholder rights” cover story, management seems to be doing the right thing:

But as it happens, most of these companies have also been buying back stock too. So per share book values have been rising steadily throughout the appalling macro climate these companies have found themselves in. Contrary to what I expected to find, these companies that are currently priced at levels making liquidation seem the most profitable option have in fact been steadily creating shareholder wealth.

This is really extraordinary. The currency is a risk that I can’t quantify, but it warrants further investigation.

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Performance of Japanese sub-liquidation value stocks: the results

Posted in About, Liquidation, Liquidation Value, Value Investment, tagged , , , , , , , , on February 9, 2010| 6 Comments »

Since last week’s Japanese liquidation value: 1932 US redux post, I’ve been attempting to determine whether the historical performance of Japanese sub-liquidation value stocks matches the experience in the US, which has been outstanding since the strategy was first identified by Benjamin Graham in 1932. The risk to the Japanese net net experience is the perception (rightly or not) that the weakness of shareholder rights in Japan means that net current asset value stocks there are destined to continue to trade at a discount to net current asset value. As I mentioned yesterday, I’m a little chary of the “Japan has weak shareholder rights” narrative. I’d rather look at the data, but the data are a little wanting.

As we all know, the US net net experience has been very good. Research undertaken by Professor Henry Oppenheimer on Graham’s liquidation value strategy between 1970 and 1983, published in the paper Ben Graham’s Net Current Asset Values: A Performance Update, indicates that “[the] mean return from net current asset stocks for the 13-year period was 29.4% per year versus 11.5% per year for the NYSE-AMEX Index. One million dollars invested in the net current asset portfolio on December 31, 1970 would have increased to $25,497,300 by December 31, 1983.” That’s an outstanding return.

In The performance of Japanese common stocks in relation to their net current asset values, a 1993 paper by Bildersee, Cheh and Zutshi, the authors undertook research similar to Oppenheimer’s in Japan over the period 1975 and 1988. Their findings, described in another paper, indicate that the Japanese net net investor’s experience has not been as outstanding as the US investor’s:

In the first study outside of the USA, Bildersee, Cheh and Zutshi (1993)’s paper focuses on the Japanese market from 1975 to 1988. In order to maintain a sample large enough for cross-sectional analysis, Graham’s criterion was relaxed so that firms are required to merely have an NCAV/MV ratio greater than zero. They found the mean market-adjusted return of the aggregate portfolio is around 1 percent per month (13 percent per year).

As an astute reader noted last week “…the test period for [the Bildersee] study is not the best. It includes Japan’s best analog to America’s Roaring Twenties. The Nikkei peaked on 12/29/89, and never recovered:”

Many of the “assets” on public companies’ books at that time were real estate bubble-related. At the peak in 1989, the aggregate market price for all private real estate in the city of Tokyo was purportedly greater than that of the entire state of California. You can see how the sudden runup in real estate during the bubble could cause asset-heavy companies to outperform the market.

So a better crucible for Japanese NCAVs might be the deflationary period, say beginning 1/1/90, which is more analogous to the US in 1932.

To see how the strategy has performed more recently, I’ve taken the Japanese net net stocks identified in James Montier’s Graham’’s net-nets: outdated or outstanding? article from September 2008 and tracked their performance from the data of the article to today. Before I plow into the results, I’d like to discuss my methodology and the various problems with it:

  1. It was not possible to track all of the stocks identified by Montier. Where I couldn’t find a closing price for a stock, I’ve excluded it from the results and marked the stock as “N/A”. I’ve had to exclude 18 of 84 stocks, which is a meaningful proportion. It’s possible that these stocks were either taken over or went bust, and so would have had an effect on the results not reflected in my results.
  2. The opening prices were not always available. In some instances I had to use the price on another date close to the opening date (i.e +/1 month).

Without further ado, here are the results of Montier’s Graham’’s net-nets: outdated or outstanding? picks:

The 68 stocks tracked gained on average 0.5% between September 2008 and February 2010, which is a disappointing outcome. The results relative to the  Japanese index are a little better. By way of comparison, the Nikkei 225 (roughly equivalent to the DJIA) fell from 12,834 to close yesterday at 10,057, a drop of 21.6%. Encouragingly, the net nets outperformed the N225 by a little over 21%.

The paucity of the data is a real problem for this study. I’ll update this post as I find more complete data or a more recent study.

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Performance of Japanese sub-liquidation value stocks

Posted in About, Liquidation, Liquidation Value, Net Current Asset Value, Net Quick Stocks, Stocks, tagged , , , on February 8, 2010| 2 Comments »

Following on from last week’s Japanese liquidation value: 1932 US redux post, I’ve been trying to determine whether the historical performance of Japanese sub-liquidation value stocks matches the experience in the US. The question arises because of the perception (rightly or not) that the weakness of shareholder rights in Japan means that net current asset value stocks there are destined to trade at a discount to net current asset value. I’m always a little chary of the “Japan has weak shareholder rights” narrative (or any narrative, for that matter). I’d rather look at the data. In this instance, unfortunately, the data are wanting.

In The performance of Japanese common stocks in relation to their net current asset values, a 1993 paper by Bildersee, Cheh and Zutshi, the authors analyzed the performance of Japanese net nets between 1975 and 1988. Here are their findings described in another paper:

In the first study outside of the USA, Bildersee, Cheh and Zutshi (1993)’s paper focuses on the Japanese market from 1975 to 1988. In order to maintain a sample large enough for cross-sectional analysis, Graham’s criterion was relaxed so that firms are required to merely have an NCAV/MV ratio greater than zero. They found the mean market-adjusted return of the aggregate portfolio is around 1 percent per month (13 percent per year).

Not a great return, but obviously a difficult period through 1987 and not an exact facsimile of Graham’s strategy. An astute reader notes that “…the test period for that study is not the best. It includes Japan’s best analog to America’s Roaring Twenties. The Nikkei peaked on 12/29/89, and never recovered:”

Many of the “assets” on public companies’ books at that time were real estate bubble-related. At the peak in 1989, the aggregate market price for all private real estate in the city of Tokyo was purportedly greater than that of the entire state of California. You can see how the sudden runup in real estate during the bubble could cause asset-heavy companies to outperform the market.

So a better crucible for Japanese NCAVs might be the deflationary period, say beginning 1/1/90, which is more analogous to the US in 1932.

It would be interesting to see an update of the performance, but, as far as I am aware, none exists. To that end, I’ve undertaken a little research project of my own. I’ll publish the results tomorrow.

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