My Experiences with Hong Kong Net Nets So Far

By Diliff (Own work) [GFDL (http://www.gnu.org/copyleft/fdl.html) or CC BY 3.0 (http://creativecommons.org/licenses/by/3.0)], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h35m / day (143 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 7h20m / day (6h34m, 3h23m, 10h43m)

I’ve invested in a bunch of net nets since talking about them in September 23rd 2015.

Here are a few things that I’ve learnt:

  • Diversification is always a good idea
  • Either Margin of Safety or Due Diligence
  • Prepare for Illiquidity
  • Volatility is much higher

So why was Diversification a good idea? Benjamin Graham always recommended 30 stocks for a Net Net stock strategy because these beaten down stocks worked well on aggregate but could easily blow up if less diversified. I went less diversified than Benjamin Graham (5% max weighting / stock = implied 20 stock portfolio), but still offering quite a bit of diversification.

And that was important since I basically chose my Net Nets purely on quantitative measurements without too much due diligence, namely:

  • Is NCAV / share less than 2/3 of Price?
  • Has the Company generated profit in each of the past 5 years?
  • Has the Company grown book value over 5 years?
  • Has the Company paid dividends in each of the past 5 years?
  • Does the Company have a 5 year average Debt : Equity ratio below 1? (Later added)
  • Is NNWC less than Price? (Later added)

Which brings me to the point that I’m glad I demanded a huge Margin of Safety. I didn’t do much Due Diligence, but demanding the first four aforementioned criteria helped screen out most Net Net stocks which were crappier in quality. In hindsight I should’ve studied more about the dangers of Hong Kong value traps before executing (I’ve learnt a lot from Mark Lin from Seeking Alpha, and I’m not compensated for sharing this), but over all I think a huge Margin of Safety has allowed me to make mistakes and learn as I invest without killing my returns.

Another thing that was a first time experience for me was Illiquidity. When I later added the other criteria (eg. Debt and NNWC) and realized one stock that I should sell immediately due to it completely failing my new criteria, it took me 3 days to exit my position. Compared to the minutes I needed to exit positions as long as the price was equal to market price, it really helped me internalize the lesson of never investing with money you’ll be needing in short term. If you’re strapped for cash, not being able to exit your positions will kill you, and that’s the price to pay if you want higher potential return since this illiquidity is the reason why many investors will avoid the stock and thus reducing competition.

Another thing I’ve never experienced was the high Volatility. All my previous stock purchases were usually blue chip large cap stocks which exhibited relatively low volatility, so it was quite interesting to see my Net Net stocks rise and drop from 5%-15% in single days. Thankfully I’ve played enough poker to be callous to paper losses, but I would’ve so panicked if I didn’t have that kind of training beforehand.

So what’s my verdict for Hong Kong Net Nets? I much prefer to continue buying Wide Moat stocks to be very honest. It requires less monitoring (You HAVE TO sell your Net Nets once it hits fair value as soon as possible if a good return is to be guaranteed, which requires frequent monitoring) and the margin of safety is much higher (it’s very hard to completely annihilated a 20 stock portfolio filled with extremely financially healthy companies with extremely durable moats).

That being said, if I can’t find Wide Moat stocks available, I’d still go for Net Nets that are of decent quality (profitable low debt companies that pay dividends). After all, my edge as an investor right now is only my capital structure and patience, which allows me to enter illiquid micro to small cap stocks and patiently wait for the returns.

I should keep maximizing my tiny bit of investor edge as much as possible while it lasts. It’s the most logical thing to do at this stage of my investment journey.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

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