Most investors wait until the end of the year before assessing the success or failure of their portfolio strategy. If you invest primarily in liquid, big-capitalization names and want to compare performance with that of the major indexes, this makes sense. But if the focus of your search is for out-of-favour value stocks, it will be more fruitful to do your analysis in mid-December when tax-loss selling throws up some really distressed situations.
With that in mind, it is timely to revisit the stock screen that epitomizes the out-of-favour and unloved: the Ben Graham net-net working capital screen. These are companies that trade not just below working capital a share (current assets minus current liabilities), but below net-net working capital, which is current assets minus all liabilities. The logic is that you sell the current assets – typically cash, accounts receivable and inventory at face value – pay off all of the liabilities and still have more cash a share than the current market price. No value is given to fixed assets that the company still owns.
These are companies trading below liquidation value per share, which in some cases would be the best outcome. Needless to say, they are almost always microcap, thinly traded and facing severe headwinds. A year ago, I wrote an article for Report on Business that listed the nine companies that passed this screen in December, 2014. They were: Webtech Wireless, Orbit Garant Drilling, Clarke, Goodfellow, Ace Aviation Holdings, Buhler Industries, Automodular, Calvalley Petroleum and Coopers Park. This year to date, the returns have ranged from a loss of 47 per cent from the resource-exposed Orbit Garant Drilling to a gain of 62 per cent on real estate developer Coopers Park after it went private and 64 per cent on Webtech Wireless as a result of a merger. In the unlikely event that you established an equal weight position in each of the nine stocks, your average return-to-date would be about 10 per cent. Not stunning, but measurably better than the 11-per-cent decline suffered by the TSX composite.
Some investors will argue that the risk-adjusted return is not that impressive because this is a high-risk portfolio, and by some measures, they are correct: With only nine stocks, it is highly concentrated, although the success/failure outcomes for each company are completely uncorrelated, so it is efficiently diversified in that sense. More to the point, the stocks are either unknown or what little is known is clearly unfavourable: Automodular, for example, had just lost a contract with a customer representing virtually all revenue – a potentially fatal event. Despite this, the stock is up 18 per cent year-to-date.
This illustrates a final point about the net-net screen: By definition, all of the stocks on it are dogs and the real risk to an investor is reputational. The stock market isn’t wrong about all of them. Some of them will turn out to be disasters and your colleagues or clients will wonder why you bought that obvious dog, even if your portfolio outperforms.
If your reputation can withstand abuse, then you may be interested in the accompanying list of net-net qualifiers as of the first week in December, 2015, courtesy of David Sandel of Simcoe Partners in New York. Stocks up to a 20-per-cent premium to net-net a share are included because low-priced stocks move in and out of contention with only a trivial price move. As always with computer databases, check the accuracy of the data and do your own homework.
Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.
Unloved
Mid-December tax-loss selling season is a good time to run a ‘net-net’ screen, made famous by Benjamin Graham, the father of value investing. Qualifying stocks trade below liquidation value per share, usually are thinly traded and face major headwinds. This year’s screen produced eight stocks, shown here.
| Company |
Ticker |
Recent price $ |
YTD % chg |
| Goodfellow Inc. |
GDL-T |
10.05 |
4.04 |
| Buhler Industries |
BUI-T |
5.55 |
-2.80 |
| Americas Petrogas |
BOE-X |
0.20 |
-20.41 |
| Redline Communications |
RDL-T |
2.06 |
-24.26 |
| Rocky Mountain Dealerships |
RME-T |
6.66 |
-30.19 |
| Pan Orient Energy |
POE-X |
1.21 |
-32.02 |
| McCoy Global Inc. |
MCB-T |
2.32 |
-44.50 |
| Logan International |
LII-T |
1.50 |
-65.12 |