Performance of Net-nets as an investment strategy

One of my friends who is not well versed in investing recently asked me what I thought was the easiest way to make money in the stock market without doing much work. For this same reason I focused my previous blog post on introducing net-net opportunities as investments. 

I have recently been investigating various studies that document the performance of net-nets in different countries. All of these studies report that portfolios of net-nets picked at random significantly outperformed the market indexes over the sampling periods. Most famous among these studies is the one by Henry Oppenheimer, conducted over the 1970-83 period. The most notable findings that should be interesting to investors are as follows:

-Portfolios with an average of 35-50 stocks were constructed every year of the study with US stocks that were trading for 2/3 Net Current Asset Value (NCAV - or "net-nets") or lower.

- Annual Geometric Mean Return from investing into this strategy was 28.5% per year.

-Portfolios of securities that were the most undervalued (as measured by the discount in price to NCAV) tended to outperform the market indexes by the widest margins.

-Portfolios constructed with companies that had negative earnings on the previous year to construction performed better on average than portfolios which had positive earnings on the same year (as they were much more likely to be undervalued).

My main takeaway from this study is that net-nets are a wonderful strategy for a small investor to exploit.  One need not learn about these companies, nor think too much about them following purchases. 2/3 NCAV is such a low price for these companies that if one is to acquire a large group of them, outperformance is guaranteed due to the severe discount that is available.

When a company is bought for 2/3 NCAV, zero value is being placed on the assets, the machinery, and other tangible assets that may be of commercial use. It is highly likely that the investor is buying many bargains - even if some of these companies turn out to be duds.

The only thing to think about would then be the following: does the investor have the stomach to buy into a large group of terrible companies and hold on to them for long periods of time until the market realizes their undervaluation? Or is it preferable to buy into safe, reputable businesses at higher prices and accept returns that may not be as high? I would argue that it depends on the investor's temperament and the time at his disposal for valuing businesses. Luckily the world of value investing allows for both of these approaches to work out satisfactorily given enough time in the market.