Net Current Asset Value Investing – A Counter Intuitive Exercise
I recall a certain William Benter, the king of horse races as I would like to call him. But even more so, the man was a brilliant statistician just as Ben Graham was. He made his money not off the stock market, but rather, the horse racing tracks of Hong Kong, a pari-mutuel betting system, just as the stock market is also a pari-mutuel betting system. Ben Graham, did pretty much the same thing, statistically with the net current asset value investing.
The general idea is to pick companies or investments with a high probability of producing a profit in the future. In Benter’s case, he would have called these returns ‘prizes’ or ‘wins’. But if Shakespeare is to be believed here, he said, “A rose called by any other name would smell as sweet.”
So what was it that these 2 gentlemen were trying to do? They wanted a sufficient return based on the laws of large numbers and they also insisted on a margin of safety when it came to placing their bets. While William Benter did not call it a margin of safety, I am quite sure he made bets with asymmetric payoffs the way Ben Graham did as well. And in the world of investing and smart gambling, you need a margin of safety, which can be expressed mathematically as a positive expected return over a large number of bets. Why a large number of bets? You would want to hit a statistical mean in your results that is representative of a large sample size. And of course to astute gambler statisticians such as William Benter himself, it is to avoid a stretch of bad luck and still come out on top, with positive returns. To do that you would need a large sample size.
And of course, bets that are asymmetric can prove to be really good investments. I will write about an example that perhaps explains this briefly.
Creative Technology Ltd
Since net current asset value investing can be somewhat counter intuitive, I have a short case study to illustrate that. The company in mind is called Creative Technology Ltd. Once a market darling amongst investors, the company nose dived when revenue fell from around $2.05 billion in 2005 to what is currently $89 million in 2018. As it stands, the company could not compete with better known, better funded and bigger competitors in the electronics space. Soon enough, losses grew and the share price reacted in a fashion that was expected. The company’s stock price declined all the way to around $1 a share in 2016. At the same time, the company had a net current asset value of $1.64. It was trading at less than two-thirds of the liquidation value. But the thing that Creative had going for it was that it had a net cash of close to $1 per share.
The diluted earnings per share from FY 2009 to FY 2017 looked like this:
As you can see, most of the years featured here yielded losses. And the company’s losses showed no real signs of abating. Now of course, I say this with caveat that not all loss making net nets produce such spectacular returns. But anecdotally, it does confirm some of the research materials out there. Sometimes, companies which you least expect to turn around do very well.
By all means, I would not call a turnaround certain for Creative Technology Ltd yet. For one, there really isn’t a drastic improvement in revenues yet. The reason for its sudden spike in price is due to announcements made by the company over its Super X-Fi products, a new launch of a new range of products.
Again, I am not recommending to just blindly buy all loss making net nets. I am only making the case that some of these loss making net nets can be really great investments. It can be extremely counter intuitive at times. After all, who would buy a company that had been predominantly loss making for so many years as you have seen above? The answer : not many. Incidentally, that produces a very low price that can reap big rewards. For the record, I did not purchase Creative Technology Ltd. And hence, you can see that net current asset value investing can be really counter intuitive. Aren’t we supposed to buy only high quality stocks to do well in investing? My answer is no! Good quality stocks are well covered and have many investors following it. Slight Disappointments in financial results can lead to disastrous losses in capital, what value investors would call a permanent loss of capital.
I just came back from overseas and I have a great interview in store for investors who want to know more about deep value investing. I recently did an interview with Professor Glen Arnold of Salford University, a academic of corporate finance, who is also a veteran and a practitioner of deep value investing. He shared much of his wisdom with me in an interview. I am currently getting the transcripts ready so stay tuned or check back regarding this.
As always, may all readers be blessed with prosperity, health and happiness!
These books which I have written are case study driven and discuss strategies, mindsets and situational approaches to employing the net current asset value strategy.
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