Author Topic: Optimal Discount to Aim for in 'Net-Net' NCAV / NNWC Stocks?  (Read 992 times)

Voodooking

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What are people's views on the optimal / acceptable level of discount when searching for the above type of companies?

I have in the past stuck to Graham's original margin of safety of 33% discount (or 66% NCAV), but can't help wondering if I'm leaving money on the table by not buying attractive stocks with a smaller level of discount?

I've also recently had success buying undervalued stocks at 70%, 80% and 90%+ of NCAV, but I'm unsure if I am being greedy or bending the rules to the extreme and taking unnecessary risk.

When Greenblatt did his famous Net Net study, he included two varying purchase levels: Up to 85% of NCAV, and up to 100% of NCAV. Both worked pretty well.

I'm also aware of a study done where Net Net type stocks were bought at 145% of NCAV, and this too provided a good return.

I don't know whether to concentrate on a bigger margin of safety or focus on the regression to mean characteristic and allow myself to diversify more and worry about the quantitative system overall rather than heavier concentration in the stocks exhibiting the biggest discounts?


mjohn707

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Re: Optimal Discount to Aim for in 'Net-Net' NCAV / NNWC Stocks?
« Reply #1 on: July 30, 2020, 10:36:07 AM »
In my experience, you can lose money with a variety of NCAV discounts with enough luck or skill
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RVP

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Re: Optimal Discount to Aim for in 'Net-Net' NCAV / NNWC Stocks?
« Reply #2 on: August 04, 2020, 05:51:07 AM »
I think the answer depends on the business on a case by case basis, and there's no way anyone can benefit from them all.

If I'm fairly confident that the company can maintain some level of profitability in the short to mid term and management's capital allocation is sound, I'd probably accept smaller levels of discounts. If I don't see any hope of profitability on the horizon, I'd probably require a deep discount and some type of potential catalyst that could close the discount in a reasonable time span.

And finally I like to examine how severe cash burn could be in a worse case scenario year (i.e. no business), and bake that into my hurdles.
 

valueinvestor

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Re: Optimal Discount to Aim for in 'Net-Net' NCAV / NNWC Stocks?
« Reply #3 on: August 04, 2020, 07:07:39 PM »
Always thought discount was dependent on desired returns.

Not that the greater the return, the greater the discount.

However, the company's earnings power + moat equates to returns on company's capital invested. Discount or premium of share price either increases or decreases the probability of return from said company.


5xEBITDA

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Re: Optimal Discount to Aim for in 'Net-Net' NCAV / NNWC Stocks?
« Reply #4 on: August 06, 2020, 08:22:26 AM »
Quite frankly, it doesn't matter how big of a discount to net working capital you buy the stock at if there isn't a catalyst to realize the balance sheet value. Simply buying at a discount and waiting for the market to wake up worked perfectly fine back in Buffett's day because, and I suspect many don't realize this, these companies were still growing net income and generating cash flow. These days it is highly likely that anything trading below working capital is not generating net income and burning cash. The market prices these shares at such a discount because there isn't confidence in the management team to turn it around which should eventually cause book value to converge with the share price, not the other way around. So, if you do find one of these net nets generating cash, by all means throw it some $ and see what happens. If not, you are dependent on getting an activist in there to boot the management team and liquidate the balance sheet or some other catalyst to realize your value. As someone who has been involved in this later example, it is incredibly time consuming and annoying, and you also need to account for liquidation / arbitration expenses which also erode your book value.