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(This is a guest post and may not reflect the thoughts and opinions of Old School Value)
Back in late 2013 I found what was nearly the perfect net net stock.
It was conservatively financed.
It was buying back stock.
It was loaded with cash.
…but somehow I managed to muck it all up.
Investors who have signed up to get free net net stock picks already know just how highly I thought of Canadian telecom firm Sangoma Technologies. When I scooped up the company in November of 2013, the company was trading at just $0.20 per share, and a massive 44% discount to NCAV.
Even better, the company was well into a successful turnaround. The business had been hit hard as the telecom industry shifted from old school copper wire to digital technology, leaving Sangoma’s main product dated and increasingly irrelevant.
To address the problem, management doubled down on research and development, planning a series of new product offerings. 19, to be exact. When I found the company, many of these projects had already been released and were making up a good chunk of revenue.
Things were looking positive for the firm and it didn’t take long for investors to recognize that fact. Within 3 weeks of my purchase, the stock was already up 40%, and 100% only 4 months later which made for an annualized 140% return.
So how did it end so badly?
Buying Net Net Stocks
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Buying net nets is really quite simple.
You look for firms trading well below NCAV, ensure that NCAV is stable or growing, and then make sure the company hasn’t taken on too much debt. Everything else is really a bonus.
To aid with research, I created my own checklist, my Core7 Scorecard, crafted from a mountain of net net stock studies, as well as the writing of Warren Buffett, Ben Graham, and Peter Lynch. All of this knowledge ensure that I’m picking the best possible net net stocks, but you can just as easily use Jae’s.
The point is to be selective and weed out the bad apples, such as resource exploration firms, pharmaceutical businesses, or companies with significant operations in China, to group together a diversified basket of high probability bets.
You don’t have to be a wiz with research, either. Warren Buffett makes knowing the intricate details of a company and industry his business, but net nets work on a different investment principle. Using a net net strategy really comes down to leveraging the population returns of net nets in general.
What attracted me to Sangoma was that it had many of the bonus items on my Core7 Scorecard, which put it in an elite group of companies.
Selling Net Net Stocks
A lot of the pros say that selling is the hardest part of investing. For net net stock investors, though, it’s really quite easy.
Net current assets provide a firm valuation. Since we’re buying based on a discount to net current assets, it also makes sense to sell a holding once NCAV is reached.
In the end, net net stock investing is really quite simple: buy solid net nets at deeply discounted prices, and sell them once they reach net current asset value. So how did I muck up my investment in Sangoma Technologies so badly?
The Earnings Fallacy
Walter Schloss says that earnings of secondary companies can be erratic, and an investor can only really project the earnings of large growth companies with any accuracy at all.
While it wasn’t profitable, Sangoma had earned a decent amount of money in the past. With how good the company’s outlook seemed, specifically the promise of a profitable and growing product portfolio, it seemed inevitable that the company could regain much of its former earnings power. When this happened, my delusional thinking went, the stock price would follow.
By summer the company had postponed the roll out of its remaining products to focus on working out the bugs in a recently released product. Earnings growth stumbled, and so did the stock, now down to $0.30 from a 52 week high of $0.42.
Then came a bit of bad news. 14 months after I bought the stock, the firm announced that it had acquired two businesses that it hoped would add meaningfully to earnings.
As a net net stock investor, I want to see a stable NCAV. Long term assets don’t factor in to my valuation, and earnings only ever play a supporting role in my investment decision. With these two acquisitions, I knew that the company would be either growing its share count, taking on debt, or handing over a large chunk of cash.
I suspected that all of these were bound to ravage the company’s NCAV but hoped that I was wrong so decided to wait for the final numbers to come in.
Stick to Your Strategy
The biggest problem retail investors have is that they don’t adopt a simple, yet highly profitable, investment strategy and then stick to it.
Ironically, a lot of small investors think that they’re Warren Buffett. They look at Buffett’s returns, and say to themselves, “I’ll just do what Buffett does.” But without Buffett’s skill and experience, this amounts to falling into the Warren Buffett trap and can prove fatal to investment returns.
Choose something simple, something doable, then stick to it.
When you stick to a strategy, you develop expertise in that strategy, and are able to make much better investment decisions as a result. Sure, flexibility is useful as an investor, but if you’re flexible without developing significant competence in any one investment strategy then you’ll just end up earning far lower returns than you otherwise could.
I chose Graham’s net net strategy because of its simplicity, but also because it has proven by far to be the most profitable value investing strategy available. Not many other strategies come close to matching the 15% excess return over the market, or 25%+ average annual returns, that Graham’s net net strategy has consistently shown.
You don’t have to be a net net stock investor (it’s not for everyone) but you should stick with a great value strategy once you adopt it.
…and that was my major mistake.
Ultimately, by waiting to see the company’s profits rebound and hoping for bigger gains, I was playing a different game than the one I had become skilled at. I was stepping outside of my circle of competence and hoping for more. I got greedy.
The Bloody Aftermath
Sangoma’s numbers came out in May and, as expected, net current assets had eroded. The company’s share count was way up, and so was its debt, while its cash balance had shrunk dramatically.
It’s net current asset value had shrunk from $0.324 per share to $0.171 per share, a drop of over 47%, so I decided to get out.
It is still possible that Sangoma Technologies could regain its former earnings power, but that’s far outside my expertise.
If I had stuck to my chosen investment strategy, and had gotten out after the price spiked, I would be sitting at a far higher annualized return than the 30% I ended up with.
About the Author
Evan Bleker is a net net investor and founder of Net Net Hunter. To receive free net net stock ideas and value investing articles, sign up now at Net Net Hunter.
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