Neglected stocks — I measure it by the ratio of market cap to average dollar volume.? 15% of my portfolio is allocated to such stocks, but I would be happy for it to be 50%, if not more. Many of my companies have a single large holder or group — Industrias Bachoco, National Western Life Insurance Company, CVR Energy, and?Berkshire Hathaway.? These companies have few analysts; there is no way for a brokerage to make money off of them.
Yes, there is a control discount for such companies, because they can’t be taken over, except by the dominant owner.? But if they are well-run, they can be great places to invest.? The dominant investor has his interests aligned with yours over the long haul.? This means that in good and bad times, a large amount of the stock is locked up, and is not available to be bought or sold.? Strong hands hold the stock, which is typically a good place to be.
I like holding cheap, illiquid companies, where there is no hint of financial stress, and they are earning decent money.? I don’t care if they are in dull industries.? If they are compounding their earnings at a decent clip, the stock will eventually catch up.
The point is to own good businesses at good prices.? That’s what I aim to do.
Full disclosure: long BRK/B, CVI, IBA & NWLI
Hi David, If you would prefer to have 50% vs 15%, why don’t you? Also, I was curious how you find good candidates in this area?
thanks,
Kapil
It’s not my only criteria for investing. I wrote a piece recently on how I generate ideas — you can see it here:
http://alephblog.com/2013/02/03/four-sources-of-buy-ideas/
I generally avoid closely held companies (unless they’re really good on my other criteria) and I’ve been wondering if I’m too strict of these. One concern is dilution risk — basically unless they need to raise money from minority shareholders, a majority holder can simply cancel your holding by awarding themselves free new shares, or other less in your face but similar measures, like delisting at an inconvenient time or restructuring the corporate structure to remove assets from the listed vehicle. Besides that they also that they can sink the business if they feel like, e.g. when an ageing founder gets dementia (who’s going to tell them to get treatment when their name is on the door?) or when the businesses passes onto incompetent heirs (are you a bit of a monarchist? :-)). Do you not worry about these factors?
If you like closely held companies, most of continental Europe (ex UK and Switzerland) is like that, there’s hardly any company without a controlling interest in the Italian large cap index. You can get many of them via ADRs.
As for true “neglect”, I like that, but I’d rather use volume on free float cap. Using full market cap is not the optimal metric (it will catch all companies with 1% free float for instance).
Those are good points. In general, I look at the past behavior of dominant owners, and see if they play fair or not. If not, I avoid them.
Hi David,
thanks for pointing to this interesting topic!
I just analysed the relationship between “Hand Strength”, Returns and Volatility. My results confirm your thesis. While there is also a strong relationship between hand strength an market cap, stronger returns only correlate with stronger hands, not with higher market cap. That’s another point supporting your idea.
See all my results here:
https://www.evernote.com/shard/s81/sh/80c4c709-8201-4c6a-9d86-b9a9fd3a3347/1cde56b101a8e320e5d595ee702e1cb5
Hi,
Have you read this paper?
“Liquidity as an Investment Style”
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1675108##
I found out about it from the Venture Populist blog posts on “Hybrid Portfolio Theory” (i.e. invest 70-90% of assets in highly liquid short term credit and the remainder of assets in “positive asymmetric investment outcomes” such as VC or low liquidity stocks).
http://venturepopulist.com/tag/hybrid-portfolio-theory/
Thanks for the paper. I have not read it, but I have read things like it. It is not a new insight. Neglect has been a part of value investing for years — Ben Graham liked buying neglected companies, as did Buffett — the academics are always playing catch-up with clever men.