How To Survive A Market Meltdown With Dividend Paying Net Net Stocks

Value investing with dividend paying net net stocks

​Tuesday, 12 July 2016

Do you know what Net Net is?

*Hint*: A stock valuation technique created by the father of Value Investing, Benjamin Graham. Famously known as the teacher of Warren Buffett.

​And you might wonder:

How much returns can I make on this stock-picking strategy?

How did it perform throughout the decade?

How did it fare during previous market crash?

Is it risky?

And last but not lease, is dividend paying net-net better than non-dividend paying net net during market collapse?

Today, it's a great pleasure to have the author of netnethunter.com, Evan Bleker to share us his finding.​ His blog was one I followed closely when I started out.

​Without further of my usual B.S, let's jump right in!


It’s 2016 and the end of the world is here once again.

At least, that’s what you would be lead to think by following the financial media. While you can never be sure of when a financial meltdown - a soul-sucking bear market - will arrive, you can be sure that one will land with a thud in the not too distant future.

​The problem with bear markets is that they are regular but unpredictable. While they happen every 5.5 years on average, there is enough variability in that pattern to not know when they will hit. Sure, someone always gets a market call right and accurately “predicts” a market meltdown before it occurs, there are thousands of analyst and pundits out there making calls every day. One of those calls is bound to be right - so which pundit are you supposed to listen to?

The trick to earning good returns over the long run and staying safe in the face of a bear attack is to structure your portfolio in a way that allows you massive upside potential while protecting your downside. That means buying conservatively financed and cheap stocks without trying to time the market.

Why stocks?

Why not a mix of assets?

Stocks are the best performing asset class over the past century - no other asset can touch them. While commodities beat cash, they also cycle up and down and don’t pay a dividend. Bonds are terrible because their coupons and principle gets eaten away by inflation. Stocks, on the other hand, increase their earnings on average over time and pay dividends to boot. Stock prices rise with inflation, even during a currency crisis, and the dividends you get act as a nice bonus to help fill out your bank account.​

​But not every stock is a great buy. High priced stocks relative to value get hammered during bear markets and debt-laden firms tend to blow up. Most “cheap stocks” strategies, on the other hand, end up being a lot of work for little gain, earning only a couple of percentage points over the market if you execute the strategy perfectly.

There is one category of stocks that provide fantastic upside potential long term while remaining buoyant during a market downturn. These stocks don’t just hold up during a market drop, they can actually produce positive returns while the rest of the market is falling apart. Despite the excellent performance profile, few if any investors bother using the strategy. The stocks that I’m talking about are dividend paying net net stocks .

​A net net stock, also known as a net current asset value (NCAV) stock, is essentially a Low Price to Book stock but where the long term assets have been stripped out of the equation. With these stocks, investors only consider Current Assets before subtracting Total Liabilities, Preferred Shares, and certain Off Balance Sheet Liabilities.

​The legendary value investor Ben Graham, Warren Buffett’s teacher, developed the strategy during the 1930s and considered the measure a great approximation for real world liquidation value. He also found that an investor could earn amazing returns by putting together a diversified basket of these sorts of stocks. How good? Graham claimed that investors should be able to earn a 20% CAGR over the course of their lives, but academic studies that followed later in the century showed CAGRs of 25% or higher.

While increased returns are usually said to be due to higher amounts of risk, that relationship just doesn’t hold with net nets. Despite the great returns, risk is substantially lower. Not only are drawdowns smaller and shorter lived than the overall market, both the Sortino and Sharpe ratios show much less risk. Just take a look at my own personal portfolio.

In the previous paragraph I mentioned that the strategy has much smaller drawdowns, while previously I claimed that the strategy actually produces positive returns on average during a market drawdown. What gives?

​The truth is that there are a number of ways that you can take advantage of these sorts of stocks. While plain vanilla net nets hold up better than the market in terms of risk and drawdowns, the best net nets to hold during a major market drawdown are dividend paying net net stocks.

I recently conducted a study of dividend paying net net stocks and took a look to see how they compare to net nets in general and the NASDAQ. Take a look at the chart:​

Over this 17 year period, dividend paying net net stocks returned a whopping 1100%! Over the same time period, the NASDAQ returned a weak 150%. Periods like this really make me feel sorry for Bogle-styled index investors.

Also note that while the chart seems to show that dividend paying net nets suffered a larger drop during the 2008/9 financial crisis, the actual raw data says otherwise. During 2008, dividend paying net nets sunk -21% while the overall market fell -42%. That’s only half the market’s decline!

Other periods fared even better. During the 2000, 2001, and 2002 periods, the NASDAQ dropped -41%, -20%, -32%. Dividend paying net nets, on the other hand, returned +0.25%, +26%, and +51.1%. Those are fantastic results!

​With results like this, why aren’t more people using the strategy?

Well, your guess is as good as mine.

One possible reason is because people are drawn to “good companies” while net net stocks are selling below liquidation value, so are almost always ugly. Value investors who know and respect the strategy are also often mislead by the media circus into believing that net net stocks just can’t be found in our contemporary markets. High quality dividend paying net nets can be tough to source in your own home country, which is why smart value investors shop for them in internationally.​

Trying to time the market is a fool’s game. It’s much better to just make good investment decisions after adopting a solid - and highly profitable - strategy. That’s what we’ve done at Net Net Hunter and the results have been fantastic.​

Evan Bleker is founder of the deep value website Net Net Hunter. He spends his time sourcing high quality net net stocks, managing his portfolio, and helping Net Net Hunter members implement Graham's net net stock strategy.

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