DEEP VALUE Videos on Net/Nets and Investing

Closing Arg

How is it possible that an issue with the splendid records of Tonopah Mining should sell at less than the company’s cash assets alone? Three explanations of this strange situation may be given. The company’s rich mines at Tonopah are known to be virtually exhausted. At the same time the strenuous efforts of the Exploration Department to develop new properties have met with but indifferent success. Finally, the drop in the price of silver last year has provided another bearish argument. It is this combination of unfavorable factors which has carried the price down from $7  1/8 in 1917 to its present low of $1  3/8 in 1923.

Granting that the operating outlook is uncertain, one must still marvel at the triumph of pessimism which refused to value the issue at even the amount of its cash and marketable investments; particularly since there is every reason to believe that the company’s holdings in the Tonopah and Goldfield railroad, are themselves intrinsically worth the present selling price. (Ben Graham on Investing)


Marty Whitman criticizes Graham and Net Nets (3 minutes Must see!)

Marty Whitman: They Just Don’t Get it.  (23 minutes) Marty says many analysts on Wall Street do not understand credit analysis.   We will explore later in this course whether the quality of credit provides a better assessment of the true cost of capital for a firm rather than “beta.”

One investor’s experience investing in Net/Nets (3 minutes)

Net/nets as value traps (5 minutes)

Good advice on behavioral investing (3.5 minutes)

Prof. Greenwald on UGLY and Cheap or Graham’s Search Strategy (8 minutes)

Greenwald on the Balance Sheet (risk of financials) (10 minutes)

17 responses to “DEEP VALUE Videos on Net/Nets and Investing

  1. The second link to the Marty Whitman video doesn’t work for me.

  2. The interviewee in the first net net video refers to an investment in a net net with earnings. However, the net net analysis in Deep Value refers to studies that show net net returns are greater for those stocks that don’t have earnings or a dividend. Makes them even more uglier I guess!

    The challenge (and I’ve yet to see how) is to weed out the companies that are really on their way to consuming all that net current asset value and dying off. The only risk mitigation I have seen so far is holding a diversified portfolio.

    • You have captured the dilemma/problem to deep value investing. Studies (Montier book) show that 5% of net/nets go to zero (the falling knife goes to $0.00) while non net/nets show less than 2% go bankrupt. BUT the net/nets that do survive outperform AS A WHOLE.
      If you cherry pick you will shoot yourself in the foot. Back in 2009 airlines traded way below their book values, so sub $1.00 and even at pennies. If you looked individually at their debt vs. equity and current conditions continued, you would have predicted a high chance of bankruptcy. So what happened?

      The Fed came in and mark to market rules for banks changed, the market turned and those about to be bankrupt airline stocks soared 10 to 20 fold. Those 10 baggers make up for a lot of 0000s of the other companies. You are playing the percentages. The reason for the returns is BECAUSE of the distress, massive underperformance, ugliness, disgust (see gold mining stocks today!) AND reversion/regression to the mean. Often when a knife is at your throat, then you act. Management, even the bad, will often act when they have no choice or Larry the Liquidator will do it for them.

      Not easy.

  3. In my prior job, I covered the Energy Sector exclusively. I used to own shares of Third Avenue Value (TAV) and was a big fan of Whitman. TAV owned shares of Nabors Industries (NBR), a company I covered. At the time, Gene Isenberg was Nabors’ CEO. I had little respect for Nabors or Isenberg and never understood all that well why TAV owned shares. The only thing I could come up with was that at one time NBR was in bankruptcy. I thought TAV might have bought debt that was later converted into shares in the post-bankruptcy reorganization.

    I attended a conference at which Marty was a speaker, I asked him why he owned NBR. It seems that Marty and Isenberg were college buddies from Yale. The fact the company was run by Isenberg was good enough for Marty. In a follow-up question, Marty was also asked about Isenberg’s compensation (it was pretty egregious – in fact, Isenberg must have even harbored some guilt as there were times he’d forfeit a piece of his comp). Marty was also on the board and, more specifically, the comp committee. The answer was that basically, Marty and Gene were old friends. Whatever Gene wanted was okay with Marty.

    I lost a lot of respect for Whitman after this exchange. Shortly thereafter I sold all my shares in TAV. Just one more reason to do your own research and analysis rather than relying on others to allocate your investment dollars for you.

    • Marty was also hammered in buying mortgage insurers back in 2007/09. If underestimated the amount of fraud and bad debt. Financial companies/banks are a special case since most of the capital used by these firms are not controlled by management. Funding can disappear overnight.

      Think for yourself
      Never underestimate incentives
      Read the proxies

      • Not a great performance by Third Avenue, behind the S&P on a 3-, 5- and 10 year basis.
        Unfair judgement?

        • I’m not sure if I’m reading the page right, but it seems to imply that over a 20-year period, Whitman has underperformed the market by an average of 2.9% pa. Colour me less than impressed!

          Berkowitz doesn’t seem to have produced any alpha over the last 10 years, either. Plenty of beta, though.

          Even Klarman’s performance doesn’t excite me. His 5-year annual outperformance was only 2.4% pa, whilst on a 10-year basis he is lagging.

          • I see the same. Perhaps guru focus data is wrong?

            There seems to be a lot of ‘talking the game’ of beating the market but who is actually doing it on a consistent basis over the long term?

          • Looking at Google, I see that Klarman’s TAVFX fund is up 7% over the decade. Very disappointing.

            Morningstar puts his style at large cap value, with an overall return of “below average” with “above average” risk.

            His fund got hammered from late 2007 to early 2009. See, this is why I don’t really buy the story that value stocks are “safer” than other stocks, and lose less. Klarman lost plenty.

            From what I’ve seen, there’s a dearth of value in the markets, so I’m not even expecting value to outperform at this stage. Perhaps the market needs a lot of unwinding to shake out some value.

    • Good point, Phil and kind of sad about Marty overlooking things because of friendship. I see it all the time though in private transactions. Many things can be overlooked especially when there is no disclosure.

  4. “If you cherry pick you will shoot yourself in the foot.”

    Not sure about that statement. Did they adjust for extraordinary items? I doubt it! NOPAT (= normalized operating profits after tax) is the way to go.

    Furthermore, would be interesting to have a study on how net- net companies faired who did something tackling their undervaluation (e.g. Share repurchases).

    I don not trust any statistic I did not fake myself!

    • OK, as long as you know why your method works and the results over time. Joel’s Greenblatt (Magic Formula) always suggest PRE-tax numbers to make comparisons easier. We will discuss Joel’s book. He said that investors using the magic formula UNDERPERFORMED since they left out the uglies stocks which then went on the most outperformance. That fits in with the theme of human intervention DEGRADING the performance of an “expert” system or method.

  5. Here’s a little example that I think you’ll find interesting. The company in question is FCCN (French connection), which is a UK clothing company.

    It became wildly successful in the late 90’s with its audacious line of clothing witht he branding FCUK [sic], standing for French Connection UK. Success wasn’t to last, though, and sales started to falter. Over subsequent years, the company seemed to flip and flop its way as a on-off turnaround story.

    One chap I heard about invested at about 50p, a time when the NCAV was a little bit higher. In the doldrums at the time, sales started to pick up, and the share price skyrocketed to over 100p. It was around this time that I invested. Alas, apparent success was shortlived, and the shares tanked again. A big mistake on my part.

    When the shares went past 100p, one commenter said that it was “obvious” that the share would do well.

    But I want to express scepticism on this. In my view there was not anything obvious. A turnaround in fortunes was by no means guaranteed. I argue that it is not business insight that created the good return, but the whole structure of the purchase. When a large slice of your share price is covered in cash, you have limited downside. The company could, of course, have continued to sink. But equally, it could “accidentally make some money” (I am reminded of the film Withnail and I when Withnail said the line “We’ve gone on holiday by mistake”).

    They’re really in-the-money options.It’s really a percentages game. You don’t “know” anything, you just buy in, knowing that a fair percentage will be duds, but others will surprise mightily, with the winners more than paying off the losers.

    It’s an appealing strategy to those who don’t think they’ve got the business insigths of Buffett, Einhorn, Ackman, etc., and just want a quantitative strategy that they can profit from.

    • That was an excellent post; a great way to view risk/opportunity. Joel Greenblatt told us that he made his moneyby HEAVILY weighting his bets. I am guessing he placed 50% of his capital into the Sears spin-off (You can be a Genius). I asked him what allows him to take such a large position. He said not the upside, but almost no downside–he said on a relative basis that Sears was 1/;10th the price of JC Penny at the time while Sears has less debt. You either don’t lost much, break-even or can make a lot.

  6. Well John, since you liked that post, I’ll give you another little example.

    This one is quite recent. It is about cruise ship operator Carnival. I presume many people have heard about Geoff Gannon. He wrote a post about it in June 2012: . Under the section “Why Carnival is a Company That Interests Me” he presented a bullish argument.

    Now let’s fast-forward to June 2014. Joel Greenblatt announced a short in the following video:, citing (03:00) that they’re eating through cash, destroying capital as they invest, and poor returns on capital.

    To that I’ll add that sales have been declining two years in a row, and currently has a PE in the high 20’s, and a ROE of around 5.3%.

    So how did Greenblatt’s short do? Not well! It’s UK quotation is up 39% over 6 months, completely trouncing the indices.

    Despite having a PE in the 20’s, what Greenblatt should have said was that it was a great contrarian play. The shares have been trashed due to declining sales and profits. CCL is a big Footsie company, so the fact it has a high PE probably indicates that the market believes that profits are depressed and that they will improve in the near future. Earnings forecasts have been going up. Last years operaitng margins were 8.7%. But both ROE and operating margins have been more than double that in the past.

    Ande remember, CCL is in a cyclical industry, which generally means that you should buy when returns are low and PEs are high. Although you wouldn’t have known it at the time, the lowering of the oil prices should help improve the margins. The general ongoing improvement in the travel industry should also help improve margins, and that’s something that you could have known.

    Investing is a funny old game, and what looks cheap can be expensive, and what looks expensive can be cheap.

    Remember that in Deep Value, it is the loss-making companies, i.e. with the negative earnings yield, that generally produce the best returns. If a company has a high PE, then that means its earnings yield is close to 0, which is close to being negative.

    The best time to have invested would have been in late 2008, around about the time the dividend was cut. OK, so 2008/9 was a great time to invest in anything. Schroders actually did a study at The Value Perspective that showed that dividend scrappers often went on to outperform the market.

    So, there’s some things for folks to ponder on.

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