Beware This Value Investing Strategy

Back in 29 March 2013, I wrote an article about one of value investing legend Benjamin Graham’s favourite investing strategies: Finding a Net-Net share. The following was how I described the strategy in the article:

“It was known that Graham pioneered an approach known as Net-Net that he used with his hedge fund, and it can be boiled down to one simple formula:

Net-Net = Current Assets – Total Liabilities

Graham looked for shares that had a market capitalisation two-thirds lower than the Net-Net value, as it provided him with a greater safety-net should the investment not work out. He wanted a greater margin of safety because he recognised that companies that were being valued so lowly by the market might have something seriously wrong with them. By insisting on a very low purchase price, he could then increase his odds of success.”

In the article, I also pointed out three local shares that were selling for lower than their Net-Net values. They are namely AEM Holdings Ltd. (SGX: A10), DMX Technologies Group Limited (SGX: 5CH), and Pan Hong Property Group Limited (SGX: P36).

As it’s been one year and eight months since I wrote about them, I wanted to see how they had fared and whether they would have been successful investments.

Share 29 March 2013 10 December 2014 % Change
AEM S$0.09 S$0.048 -46.7%
DMX Technologies S$0.24 S$0.160 -33.3%
Pan Hong Properties S$0.22 S$0.157 -28..6%

Source: S&P Capital IQ

With the SPDR STI ETF (SGX: ES3) actually moving up slightly by 1.2% in the same period (the SPDR STI ETF is a proxy for the Straits Times Index (SGX: ^STI), Singapore’s market barometer), the trio of shares have certainly been very disappointing for their investors.

At the Motley Fool Singapore, we’re staunch advocates of long-term investing, so evaluating these investments over a timeframe of less than two years might not seem appropriate. But, here’s something to note: Net-Net shares generally have businesses which either have stagnant or shrinking intrinsic values. This increases the risk for investors the longer they hold onto these shares.

The deterioration in the value of such shares is apparent when we look at AEM Holdings and Pan Hong Properties. Back in 29 March 2013, both shares had net-net values of S$50 million and S$298 million respectively. But today, as a result of a deterioration in their businesses and/or balance sheets, their net-net values have decreased to S$31 million and S$221 million.

A Fool’s Take

Given the experience of the aforementioned trio, it would seem that investors would have to be wary of this strategy of investing in Net-Nets. But, that’s not true. What investors should be wary of, is betting heavily on any statistically cheap-looking share (a Net-Net share is one example of an investment that can be described as statistically cheap) in the hopes of earning out-sized returns.

When Graham invested using the Net-Net strategy, he did so in a widely diversified manner, at times owning up to hundreds of such shares. That’s because he knew that each share can be rife with danger when bought individually (as mentioned earlier, their underlying businesses can often be in serious trouble) – it’s only when he owned a huge basket of them can the risks be lowered substantially. Investors ought to bear this in mind.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.