Did you know that the Net-Net strategy or as some call it, ‘Cigar-Butt’ Investing was the most prominent strategy that got Warren Buffett to his first million by the age of 30?
He picked up this strategy from his teacher, Benjamin Graham – better known as the author of value-investing bibles such as The Intelligent Investor and Security Analysis.
So it is now our chance to pick up this same strategy and replicate how the Omaha Oracle was able to leverage upon this method to kick start his investing journey!
The Net-Net Strategy
Taking a look at Warren Buffett’s net worth through the years, one would see that it was during the age range of around 53 where he realized that Ben Graham’s Cigar Butt strategy was not scalable with large amounts of capital (we’re talking Billions).
This is also when he decided to work with Charlie Munger’s strategy of buying wonderful businesses at fair values, which allowed far greater expenditure of his capital and thus, growth of wealth.
After all, growing $20 million by 20% is very different from growing $20,000 by 20%.
Many investors nowadays fixate on Buffett’s current investing methodology.
However, what many do not know is that it is not as applicable to retail investors like you and me. This is for the simple reason that we do not have immensely large cash piles.
For the likes of you and me (unless you have a net worth of a billion or more), we should stick to the original strategy that got Buffett his first million.
On picking up cigars...
In summary, the idea is that buying these stocks is like finding a mostly smoked, discarded cigar.
“A cigar butt found on the street that has only one puff left in it may not offer much of smoke, but the bargain purchase will make that puff all profit.” Buffett explained in his letter to Berkshire Hathaway shareholders.
Here’s the (not-so) secret formula:
If a stock price is less than 2/3 of the difference between its current assets and liabilities, it is a Net Net stock.
Because the share price is selling at such a ridiculously cheap price, you will still be able to buy it at a fraction of its entire net worth!
They tend to be so cheap, even when the entire company goes into liquidation, you are still able to make a profit out of it! (And in fact, you probably want it to go into liquidation. You’re more liable to be better off versus having the company suffer long term and lose value for you as a shareholder!)
We won’t elaborate too much on the Net-Net strategy as we have a dedicated post and video lesson on it. Feel free to hop on over to learn more before diving deeper into this article.
How We Picked our Top 5
As previously mentioned, we like to do things quantitatively on the first-go to prevent our investor biases from coloring our judgement on certain stocks.
Using Dr Wealth’s proprietary stock screener, which has several presets, includes one that automatically includes the Net-Net formula into the system. This allows us to filter out potential cigar butts and we came up with a pool of 72 stocks to select from.
By the way, this screener is made available to all graduates of the Intelligent Investor Immersive Programme through an Intelligent Toolkit. Don’t say, “Bo Jio!”
To make our selection more stringent, we turn to Dr Joseph Piotroski’s F-score to find fundamentally strong low price-to-book stocks that are worth investing in.
As we have already added conservativeness (taking ⅔ Net Current Asset Value), we do not need to adopt the full 9-point F-score. A proxy 3-point system known as POF score would be used instead.The stocks selected have a POF score of 2 and above.
To learn more about the POF score and how we use it in our investment strategies, click here.
Why these 5 stocks?
To facilitate your reading, we have structured the content into clear and concise points to sum up what you have to know:
- What does the company do?
- What are their assets ?
- Why is the stock undervalued (Net-Net)?
While there isn’t a hard and fast exit strategy, here at Dr Wealth we ourselves would either sell at 50% profit or 2 year holding period, whichever comes earlier.
This is due to the fact that such stocks are of higher risk as compared to other counterparts given that they all have trouble in recent years or have falling profits/revenue. We also wouldn’t want to be stuck in a value-trap for years and would rather re-allocate our capital to more promising counters we identified.
Even though these stocks are not without their issues, they present a good buy as they are currently trading significantly below their Net Current Asset Value!
Without further ado, let us present to you our Top 5 Net-Net stocks in Singapore that we feel Ben Graham and young Warren would have definitely be interested in.
Do note that they are arranged in no particular order and valuations are as of time of writing. Net-Net discount is the difference between Net-Net price and current tradng price.
#1 – Sin Ghee Huat (SGX:B7K)
What does the company do: Steel. The company machines, processes and supplies stainless steel to various business sectors.
Trading, Engineering and Construction contribute 71% of the revenue.
What are their assets: Inventories, cash and receivables. As a metal trading firm, it is normal to have a large inventory which accounted for almost half of the total assets. There is also a significant amount of cash and trade receivables which constituted 29% and 12% of the total assets respectively.
Why is the stock undervalued (Net-Net): Poor Performance. The business performance has been weak over the past 5 years, mainly dragged down by the weak global steel market, which is suffering from weak demand, over-capacity and excessive inventories.
#2 – Sunright Ltd (SGX:S71)
What does the company do: Semiconductor test and burn-in services. They provide management services and research and development in burn-in and test-related activities. The Company also manufactures burn-in equipment and substrates, assembles electronic, and electrical components, as well as provides semiconductor testing services.
What are their assets: Cash, Investments and receivables. Sunright is cash-rich with cash and trade receivables constituting 42% and 17% respectively. Investments constituted 35% with it being channelled to its 2 key growth drivers – the automotive and data centres.
Why is the stock undervalued (Net-Net): Poor Performance and Macro Volatility. The business performance has been weak over the 1HFY2019, with the group expecting to report a loss. This is also coupled with the current US-Sino Trade wars. CNA reported that Washington’s blacklisting of technology giant Huawei has taken a toll on semiconductor shares. This would definitely have a trickle down effect, harming the top-line of the company.
#3 – SP Corporation (SGX:AWE)
What does the company do: Tyre Distribution, Commodities Trading and Mining & Engineering.
What are their assets: Cash and receivables. SP Corporation is cash-rich with cash and trade receivables constituting 15% and 84% respectively. Receivables are debts owed to a company by its customers for goods or services that have been delivered or used but not yet paid for.
Why is the stock undervalued (Net-Net): Poor Financial Performance. The business performance has been weak over the past 4 years with earnings falling by 42% from 2015 to 2018. In 2017, SP Corp’s full-year net profit fell 75 per cent as higher costs and expenses swallowed up a revenue increase.
#4 – Global Invacom (SGX:QS9)
What does the company do: Satellite Broadcast Solutions. They are one of the world’s largest developers, manufacturers and suppliers of satellite and TV peripheral equipment. The Group is 1 of 7 companies worldwide involved in research and development, design and the supply of Satellite Communication products to large-scale satellite broadcasters.
What are their assets: Cash, Investments and receivables. Global Invacom is inventory heavy with it constituting of 34% of its assets. Investments constituted 13% with it being channelled to its key growth drivers of Satellite engineering while receivables constituted 27%.
Why is the stock undervalued (Net-Net): once SGX watchlisted. GInva was queried by the SGX which flagged unusual movements in its share price after the counter surged from around $0.03 to $0.52. In response to the query, the company said at the time that negotiations were still ongoing between itself and Tactilis Sdn Bhd. It added that it was unaware of any other possible explanation for the unusual price movements. However, on Apr 21st 2019, they said that the proposed acquisition of Tactilis Sdn Bhd was called off due to “difficulties in fulfilling all of the conditions precedent in the sales purchase agreement”. This caused the stock to surge 78.6% the next day and put an end to the entire saga with Tactilis.
#5 – Goodland (SGX:5PC)
What does the company do: Residential Developments. They are a property developer specializing in Residential Developments. They have an established reputation for building quality, signature, environmentally friendly developments.
Most of their projects involve Condominiums and Terrace Houses.
What are their assets: Investment properties and Inventories. Being a property developer, it would be normal for Goodland to have a larger percentage of its assets in Investment properties and Inventories (building materials) constituting of 66% and 60% respectively.
Why is the stock undervalued (Net-Net): Undiscovered stock. The property developer is flying under the radar as many investors have yet to take notice. This could also be coupled with its fall in Revenue from 69.8M in FY17 to 30.9M in FY18 of 55.7% while its profits fell by 84% from 9.46M to 1.52M.
So there you have it.
Our top 5 cigar butts, worthy of being picked up and puffed.
“Cigar butt” stocks are not sexy nor glamorous, hence most people avoid them.
These stocks are very unloved and unfamiliar to most people and may even have problems like going into bankruptcy.
However, because the share price is selling ridiculously cheap, you will still be able to buy it at a fraction of its entire net worth – and you’re even more likely to profit when they go into liquidation!!
Small, retail investors like us don’t have to deal with ‘having too much money on our hands’. Hence, we are in the best position to exploit the Net-Net strategy.
Warren said in a Berkshire interview that if he had $1 million, he would invest in ‘mosquito’ stocks—the small cap, the Net Net, the unsexy and the cigar butts.
The net net stocks are small caps which have very low liquidity and trading volume. However, we feel that the article is targeted to those retail investors who want to vest lesser capital into these counters and we would always advise to slowly buy into a stock.
If you like the strategy we shared with you above and want to achieve even better returns safely with minimal effort, we would like to invite you to grab a free seat for our upcoming introductory course.
Till next time!
Value Investor. Die-hard Liverpool Fan. Foodie.