All courses of action are risky, so prudence is not in avoiding danger (it’s impossible) but calculating risk and acting decisively. Make mistakes of ambition and not mistakes of sloth. Develop the strength to do bold things, not the strength to suffer.
~Niccolo Machiavelli
Net-Net guru Geoff Gannon breaks down the secret ingredient to successful Net-Net investing using the example of one of his recent Japanese Net-Nets which received a buyout offer:
What special skills did earning this 130% return require? You didn’t need smarts. The key information – the cash and securities per share – was publicly available. Anyone could find it on the Internet. And the gap was egregious. If you looked at hundreds or even thousands of stocks – in Japan and around the world – Sanjo would’ve popped as a Ben Graham bargain.
No. You didn’t need smarts. You didn’t need any real insight or appetite for risk or anything like that. You just needed to embrace uncertainty.
Sanjo was certainly worth more than 200 yen a share. A lot more. No reasonable person would deny this. But most reasonable investors probably wouldn’t buy the stock. Why? There was no catalyst. No reason for the stock price to rise. Sanjo is a Japanese company. It’s a micro cap. Stocks like that don’t get bought out.
As it turns out, Sanjo’s largest shareholder had been in “intensive discussions and price negotiations with management over the last year.” So there was a catalyst. It’s just that nobody – except the company’s biggest shareholder and its president – knew about it.
That’s the uncertainty in net-nets. Most of the best net-nets have this certain/uncertain duality. It is certain the stock is selling for less than it’s worth. It is uncertain how the stock will ever sell for what it’s worth.
Net-nets are half about knowing and half about believing. They are part knowledge and part faith. If you can’t accept both of those ideas at once – you’ll never be a good net-net investor.
You can only know the stock is selling for less than it’s worth. You simply have to believe the stock will someday sell for what it’s worth.
This is probably also why Net-Nets are best bought in baskets and groups. You usually don’t have enough of a clue of what the catalyst will be to concentrate your holdings into just one company.
So it isn’t necessary to be super smart in your analysis as long as you are super smart in your actions. The big problem for a lot of would-be net-net investors is not bad analysis. It is bridging the gap between analysis and action.
And this is the key point to make about net-nets that earn low returns on equity. You don’t have to see how mean reversion will occur for it to occur.
The future does not care if you can envisage it ahead of time. It comes whether you see it or not. The good news: You can bet on things you can’t imagine.
Close your eyes and jump!
A House Rises 