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How To Destroy Your Net Net Stock Portfolio

Are you tired of building wealth? Would you rather watch your money burn? One of Canada’s leading newspapers came out in 2013 with a list of net net stocks that it expected would produce amazing returns. Author Robert Tattersall, co-founder of the Saxon family of mutual funds, looked back in time and put together a basket of net nets trading on the Canadian markets at the start of 2012. His strategy was simple: a basket of Canadian net nets, 21 to be exact, trading at no more than a 20% premium to NCAV, with no additional filtering. Over 2012 the stocks would have performed very well, recording an 18% gain versus the TSX’s 4% return. That result is on par with the returns of net net stocks generally. Over 2013, however, returns began to sour. Rather than the market crushing performance of the previous year, Tattersall’s basket of net nets actually underperformed the market, returning just 2% compared to the market’s 7.2% return. What Went Wrong? Part of the problem was the holding period. Net nets show their best yearly performance as a group over a 1 year holding period but then perform worse the longer you hold onto the stocks. Over a two year period, a net net stock’s CAGR drops in a meaningful way. Over a 3 year holding period, results are even lower. Returns decrease step by step until in year 5 a lot of the advantage of owning a basket of net net stocks is destroyed. If you want to run a net net stock portfolio, annual rebalancing is a must. But holding period length is not the only thing potential net net stock investors should keep in mind, and it wouldn’t have been responsible for the large drop in performance his portfolio saw. There is a fair amount of variance in portfolio returns, after all. But, astute readers will notice two other fatal flaws. It’s no secret that net nets perform spectacularly when you stick to the strategy over a long period of time. Not all net nets perform the same. I crafted my Core7 Scorecard to help identify the net nets that have a better chance of outperforming net nets in general and help avoid firms that will disappoint. While it’s impossible to avoid every firm that will produce a loss or ensure that all the highest returning net nets are in your portfolio, it does a good job of stacking the odds in your favor. One of the key requirements in my scorecard is avoiding Chinese net nets and resource exploration companies. China has become famous in the West for its spectacular growth, but it’s also developed a bit of a reputation for offering up western market listed firms that are nothing more than frauds. These companies over-inflate their Balance Sheet figures, record assets they don’t actually have, and even tally up growth in revenue or earnings that just didn’t happen. Understandably, these companies don’t make for the best net nets. After all, if you’re going to be basing your investment decisions on Balance Sheet figures, it’s usually best to stick to firms you have reasonable grounds to assume are producing accurate financial statements. Resource exploration firms are a whole other can of worms. While they may have more accurate financial statements (i.e. they’re less likely to be outright frauds), these companies have a long history of destroying shareholder wealth. They start with a public offering of stock and then spend the money trying to find resources to harvest. This process can take years, if they find anything at all, and the entire time the company keeps draining its bank account. Most companies never actually find a deposit, but do a very good job of eroding shareholder value. 9 Net Nets for 2014? Maybe? These facts aren’t exactly a secret on the Street, so it’s interesting that David Sandel of Simcoe Partners would choose to include Chinese reverse merger and resource exploration firms in his followup portfolio for 2014. Just like Tattersall’s 2012/2013 portfolio, Sandel picked a basket of net nets that he suggested investors purchase for 2014: Automodular Corp. ( OTCPK:AMZKF ) -10.16% Monument Mining Ltd. (MMTF) -41.17% Energold Drilling Corp. ( OTCPK:EGDFF ) -50% Indigo Books & Music Inc. ( OTC:IDGBF ) +46.25% Greenstar Agricultural Corp. (GRCGF) -51.17% Goodfellow Inc. ( OTC:GFELF ) +5.73% Mirasol Resources Ltd. ( OTCPK:MRZLF ) +20.44% ACE Aviation Holdings Inc. ( OTC:ACAVF ) 0% Coopers Park Corp. ( OTC:CJPKF ) +43.93% All 9 net nets were still listed on Google Finance 12 months. If equally weighted, the portfolio would have produced a loss of -4.02%. A quick look at the firms is instructive. Of the firms selected, 3 were resource exploration firms (Monument, Energold, Mirasol) and one was actually a Chinese firm (Greenstar). The return to this group of 4 stocks was an average loss of -24.38%. If investors had skipped over the resource exploration and Chinese firms, they would have enjoyed a much more rewarding +17.15% return versus the TSX’s +6.23% gain. Not exactly statistically significant, but illustrative. Wise Stock Selection for the Best Returns At this point, astute readers will point out that these exploration firms were purchased right before a big drop in commodity prices generally. That’s a fair point, and one more reason to avoid resource firms altogether unless purchased in the depths of a serious bear market. While retail and industrial firms can turn themselves around with effort, planning, and decent judgement, the fate of resource firms are more or less wedded to commodity prices. Net nets don’t work out every year, and not every company will see positive returns. Seeing losses from time to time comes with the territory when buying net nets. Still, despite the occasional loss, net nets produce better returns over the long run than any other value strategy. Returns are consistently above a 25% CAGR in academic studies and my own portfolio has done very well. You shouldn’t just buy any net net, however. Some net nets have a much greater chance of suffering large losses; while other net nets have characteristics associated with outsized returns. Most of my net nets are debt free, have been growing NCAV, are increasing earnings, were bought with a PE below 10x (less than half the market PE!) and at an average discount to NCAV of 55%. If you want to make the most of your net net stock investing, you really have to group the best possible stocks into your portfolio. Why would you do anything else? Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

No Danger From COP21 For Airline And Shipping ETFs

The world is striving to arrest the rise in the global temperature to 2 degree Celsius by the end of this century. In that vein, global leaders assembled in Paris at the COP21 meet – which was the 21st annual conference of parties – to chalk out an elaborate and comprehensive plan to lower carbon emissions and moderate the warming of the planet. In any case, efforts to check global warming have been constant across countries. Not only developed economies, but the emerging ones too are pushing themselves to attain this goal. However, following two weeks of sharp diplomacy, 196 countries agreed upon a historic agreement on climate change last Saturday. Per the agreement, developed economies will provide a minimum of $100 billion to developing nations a year to finance the needed reforms they can’t pay for to restrain greenhouse gas emission. Needless to say, clean energy stocks and ETFs as well as fossil-fuel free investments will enjoy a huge benefit in the coming days. Is There Any Loophole in COP21 Treaty? Two key pollution causing sectors, international shipping and aviation were excluded from the COP21 treaty. International shipping emits 2.4% of global greenhouse gas emissions, almost the same that the whole of Germany does. Total aviation gives up about 2% of global GHGs, and international flights make up about 65% of that number, per the source . These emissions do not come under the territory of any specific country and thus is out of the COP21 treaty. In fact, greenhouse emissions are estimated to rise exponentially by 2050. However, International Civil Aviation Organization (ICAO) has indicated to that it will plan a global market-based measure to lower carbon emissions. The agency has vowed to perk up fuel efficiency by 1.5% each year until 2020 and ‘to halve 2005-level emissions by 2050’, per citylab.com. International Maritime Organization also “has set an energy efficiency requirement for ships built in 2025, but not an overall carbon emissions target.” Needless to say, technological advancements are being tested rigorously in the aviation and shipping industry for decarbonization, but it has a long way to go. As of now, these two sectors are not as vulnerable as the fossil-fuel related sectors from Paris climate summit. Investors can safely play or dump airline and shipping stocks and ETFs on their inherent sector strength or weakness. Below we highlight two sector ETFs in detail. Airline – U.S. Global Jets ETF (NYSEARCA: JETS ) This fund provides exposure to the global airline industry, including airline operators and manufacturers from all over the world, by tracking the U.S. Global Jets Index. In total, the product holds 34 securities with double-digit allocation going to Southwest Airlines, Delta Air Lines, American Airlines and United Continental. Other firms hold less than 4.44% share. The ETF has a certain tilt toward large-cap stocks at 62% while small and mid caps account for 24% and 14% share, respectively, in the basket. The fund has gathered $48.4 million in its asset base while sees moderate trading volume of nearly 40,000 shares a day. It charges investors 60 bps in annual fees. The fund added 13.2% in the last six months (as of December 15, 2015). Guggenheim Shipping ETF (NYSEARCA: SEA ) The $30.2 million fund tracks the Dow Jones Global Shipping Index and holds 26 securities in its basket. The index reflects high dividend-paying companies in the global shipping industry. As far as the sector breakdown goes, the fund is concentrated on the industrial sector with about 58.8% exposure while the rest is attributed to the energy sector. In terms of geographic distribution, the U.S. takes the top spot with more than 36% of focus, followed by Denmark (19.1%), Japan (13.5%) and Greece (9.5%). The product charges 65 bps in annual fees for this diversified exposure. However, the fund was off about 31% in the last six months (as of December 15, 2015). Original Post