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Negative Enterprise Value Screen Strategy

March 26th, 2010

21 Comments

Stock Screen Strategy and Backtest Series

Negative Enterprise Value

I’ve written extensively about how companies with negative enterprise values are great value stocks and in a previous article, I went through how you can search negative EV stocks off the Yahoo screen. But let’s see how the screen actually performs over a longer period.

In case you aren’t familiar with the formula for EV:

Enterprise Value = Market Capitalization + Total Debt – Excess Cash

Excess Cash = Total Cash – MAX(0,Current Liabilities-Current Assets)

Negative EV Screen Strategy

If done correctly, looks like this strategy is hugely profitable, but it does come with a lot of volatility. On paper of course. Don’t know whether anyone has ever done it so I can’t guarantee that this works 100%.

Looking at the results below, you can see some monster gains by the negative EV stocks as well as huge drops which would have turned anyones stomach.

Neg EV vs S&P Yearly Results

Negative EVS&P500
200147.5%-2.5%
20028.5%-23.8%
2003237.7%28.5%
200472.8%3.9%
20057.0%10.3%
200637.0%10.4%
2007-41.4%-4.8%
2008-53.8%-38.1%
2009192.3%47.4%

Backtest Conditions

  • No OTC stocks
  • No financial stocks
  • No ADR stocks
  • EV is less than 0
  • Daily volume greater than 20k

Backtest Results

I’m not surprised that negative EV stocks perform well overall given that even my random set of neg EV stocks beat the market last year. But over a span of 9-10 years, the result is mind blowing.

Negative Enterprise Value Screener

In case you missed it, you can view negative EV stock screener for yourself. Results are updated every few days.


Disclosure

No positions in any stocks mentioned

About Jae Jun

Jae Jun has written 529 value investing articles.

Jae is the founder of Old School Value and has a mission to empower every investor by providing tools, tutorials and educational material so that they can invest successfully on their own.

Recent posts by Jae Jun

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  4. DIVX Negative Enterprise Value Stock Analysis
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  • csucag

    This beats Greenblatts magic formula doesn’t it? Should I scrap following the magic formula on these results? Why don’t you hold any of these stocks Jae Jun or are you managing to beat these returns in your personal portfolio?

    What about over a longer time period? What if we rank the stocks (where possible) on ROC as well like the magic formula?

  • http://www.oldschoolvalue.com Jae Jun

    Many strategies beat the magic formula. This is just one of them.

    I don’t hold any of the ones list but I hold companies that were on the list and so far I have beat the returns in my 2 years only and we need more time to see whether I can maintain it.

    I’m sure there are endless amounts of possibilities, but I’m showing how -ve EV stocks can be a good starting point.

  • john

    hi Jae- thank you always for all the great work. can you explain a little more on the specification – i.e. holding period and rebalancing, how many holdings, what you are assuming if one gets acquired (redistribute gains to other stocks or stay in cash, etc?)

  • john

    jae, would this work for financial stocks, or should they be excluded?

  • http://www.massrefunds.com itconsultant

    Read this article by renowned Prof Damodaran.

    http://aswathdamodaran.blogspot.com/2008/12/entperise-value-is-negative-is-that.html

    The key points being
    1) The computed enterprise value may not have captured all of the debt outstanding in the firm.
    2) The cash that is netted out to get to enterprise value is usually from the most recent financial statement (rather than the current date used for market cap).
    3) Some services are sloppy about their definition of market value and seem to mix up market value of equity with market value of the firm.

  • csucag

    Thanks for the reply Jae Jun.

    I too have beaten this -ve EV stocks method over the last two years by about 5 percentage points. However I would be suprised if I had been investing for the last 10 years if I could have beaten the returns suggested here. Something I have always wondered is what returns people who write blogs/comment on these blogs/are members of value investors club can achieve in their personal portfolio. Would anybody like to share?

    Regarding your comment that many strategies beat the magic formula. If so, how come Greenblatt has suggested at least a couple of times that he can’t find anything better than the formula (and if he did he wouldn’t share it with us)? Have you achieved what Greenblatt can’t or are there reasons we can’t follow these strategies.

    Regards
    csucag

  • http://www.oldschoolvalue.com Jae Jun

    @ john,
    for the tests I run, I exclude all financial and OTC stock.
    Portfolio of 15 stocks rebalanced every 6 months. If a company is acquired, the portfolio remains in cash until the next 6 months.

    @ itconsultant,
    Thanks for the link. Makes sense, but from theory and practice, the results don’t lie.

    @ csucag,
    I openly share my performance every month and I know that many other bloggers do as well. Most of the people I do track and keep in touch with also do very well.

    Regarding Greenblatt, I believe his formula is for a mainstream audience. He is target audience is very broad which would mean that he has to be able to accommodate so many different risk levels.

    If this strategy was ever published, 99% of the people would hate it because it deals with small & micro caps, companies that are in trouble and huge amounts of volatility.

    So I wouldn’t say that I’ve achieved something that Greenblatt hasn’t. I just have the luxury of being able to follow these explosive strategies without being hindered by the mass media.

    Imagine what would happen if the magic formula was down 40% compared to 4% for the S&P.

  • http://boyplunger.com Roberto

    Those of us who have our $$ on the frontline know well how some of these strategies feel like. It is really ugly at the bottom. You feel like a smashed sardine… and you are never in good company. So you have to really really focus and have done all your homework to withstand an onslaught of negativity. You get bounced around like a pinball in a machine and self-doubt is your second name. I went through a nightmare with bee, but it recently paid off with a huge return.

    However, I would not recommend the average investor these seemingly safe strategies. Safe is not synonym of low volatility. And most of these stocks will have several failed jump-starts. Almost everyone invested in these stocks will complain and will make you feel like life is hell. Like you have fallen down the stairs in a crowded soccer stadium and you, at the bottom, are struggling to find a crevice where you can breath fresh air and have everyone’s feet and legs all over your head.

    Of course, when the gigantic pay off comes through and the stars finally align, the world couldn’t be better.

    Thank you for your posts, Jae.

  • http://www.blogvesting.com valuegeek

    This screen tends to find small/micro cap companies, therefore a more appropriate index will be a small cap index, such as the S&P Smallcap 600. Small caps are more volatile, and the returns for holding them should be higher than the S&P 500, to compensate for the added risk. Is there sufficient excess return above and beyond the risk-adjusted return? As a mechanical trading strategy, I strongly doubt that it is superior to the Magic Formula strategy on a risk-adjusted basis. The Magic formula is more agnostic towards capitalization, and in fact tends to concentrate on the midcaps, and is generally less volatile and tends to turn up more enduring value.

    That said, I have employed this screen in the past as an idea generator. I have found that it is most useful in bear markets, when small caps get beaten down to ridiculous levels, and many stocks trade at negative enterprise values for no reason. In bull markets, stocks trading at negative enterprise values tend to have problems serious enough to overcome the generally optimistic mood, and hence are best avoided.

  • http://can-turtles-fly.blogspot.com/ Sivaram Velauthapillai

    I could be wrong but I suspect this strategy looks so good because of survivorship bias. Does your backtest data account for survivorship? That is, companies that are bankrupt don’t show up in the (most recent) data so you may be backtesting only the companies that have survived to the present time.

    Since negative enterprise value stocks tend to be low-quality, often on the verge of failure, the results will look really good if those failed companies aren’t included.

    It’s really hard to adjust for survivorship because you need to find data that includes bankrupt companies. Practically none of the free data out there includes this (as far as I can tell.)
    .-= Sivaram Velauthapillai´s last blog ..Quick update on the markets =-.

  • http://www.oldschoolvalue.com Jae Jun

    @ Roberto,

    That’s the beauty of value investing. Buying good companies is a fine strategy but if you dive deeper, these loser companies are frightful and it’s a pain to explain your rationale but when it works out, boy does it feel good to know that you aren’t just another lemming and that your research and conviction was correct.

    @ Valuegeek,

    Very true. For the mass public, the magic formula is a perfect strategy.

    “In bull markets, stocks trading at negative enterprise values tend to have problems serious enough to overcome the generally optimistic mood, and hence are best avoided.”

    I didn’t think so much about this. It would explain why 2007 was such a down year for this strategy.

    @ Sivaram,

    The backtest only accounts for companies that meet the criteria and is then held for 6 months and either discarded or kept again. If the company goes bankrupt it is replaced in the next 6 months.

    So you are right that bankrupt companies will not show up in the screen to begin with.

    But for a mechanical strategy or even as an idea generator, most people shy away from bankrupt companies so I think this data is fine.

  • k007

    this is a great screening tool but mechanically it would be brutal.

    if you bought at peak of 2007, you would have sustained a total of 70%+ loss. i think it would be tough for a lot of people to hold through that turbulence!

  • Mike

    Jae,

    I think your screen has some issues. Just looking down at the produced list, there are a number of companies that are for sure not net-nets if you actually take a look at their balance sheets…

    In fact, I wouldn’t be surprised if MOST of them do not meet your criteria, though I haven’t looked at them all.

  • http://www.oldschoolvalue.com Jae Jun

    @ Mike,

    This particular screen isn’t a net net screen. It is for negative enterprise value which isn’t limited to net nets.

  • http://can-turtles-fly.blogspot.com/ Sivaram Velauthapillai

    Sorry I didn’t respond earlier Jae.

    I think this is a useful screen; I’m not arguing against that. I agree with you that it’s a good starting point.

    However, I think it’s hard to say that the strategy is as good as the back-test indicates. The results won’t come anywhere near what your back-test shows, simply because of survivorship bias. I am pretty sure that anyone following your procedure wouldn’t produce a 50%+(?) annual return over the S&P500. A lot of the poorly performing ones in their portfolio wouldn’t be in your back-test list because those companies would have dissapeared.
    .-= Sivaram Velauthapillai´s last blog ..Quick update on the markets =-.

  • Mike

    many of these companies do not have negative EVs, or, the EV numbers displayed in the screen are wrong.

    For example: XING and QXM do not have EV’s of over -2 billion.

    IMOS is not a negative EV company.
    The Dec 2009 BS shows: $121 cash; $148 short term debt; $419 long term debt.

    COGO is not a negative EV:
    Dec 2009 BS shows: $97 cash; $17 short term debt; but market cap of $246M

    MJH is a negative EV but not anywhere close to what you have listed
    Jun 2009 BS shows: $71 cash&securities; $17 secured debt; $15 other debt. Market cap = 13M. The EV is not anywhere close to -249M

    CAST is not a negative EV:
    Dec 2009 BS shows: $48 in cash, $75 in term deposits; $15 in short term debt; $20 in long term debt. But market cap is over $300 million…

    I only looked in detail at the top 6 of your list. They all have data issues. I am familiar with a few companies further down the list and I know the do not belong here as well but I won’t list the exact figures.

  • Pedro

    I’ve look to your screener and the stock in the worksheet appears to be down by a large percentage for almost all… How can you explain that the performance is up on the graph ? Is it a bug ?

  • http://www.oldschoolvalue.com Jae Jun

    @ Pedro,
    The performance of this particular article was based on 6 month rebalancing. Not all the stocks are down. If you ignore the chinese ones, you would have been actually very well off.

  • http://- Adrian

    With the same set of criterias for the period 3/31/2001 – 9/5/2011 , with a monthly rebalancing, 1 percent set as loss from friction or slippage and 15 stocks tweeked with a prop RANK managed to get a much lower drawdown with a total return for the period of 7500%, with even more proprietary set of rules for finding value, with a friction set at 4% the backtest “eeked” out a 50.000% for the mentioned period. Thanks Jae

  • http://s1203.photobucket.com/albums/bb393/Adrian_Suciu/System%20results/ Adrian

    Just had to come back with some proof, besides the recent drop in performance the system did ok, and also in 2005 this value screen had a reluctancy to perform, I can only guess it can be because of “irrational exuberance”
    One way one can even look at a china stock right(or outside US) now is when it has some manageable debt on the balance sheet, hoping that the bank did some dilligence.
    Sorry for mistypes, english is not my strong point.
    http://s1203.photobucket.com/albums/bb393/Adrian_Suciu/System%20results/
    All the best to all, Adrian Suciu

  • drjjm

    513 x 1.87 x .79 = 758
    How do you get 2143?