Update on the Japan net-nets, and a quandary I found myself in

This post is two independent lines of thinking that are related in the end.  If you're short on time, or get tired of my writing each can be read alone, although I'm biased, I think you should read the entire thing..

Japan update

Back in October/November I wrote a post detailing (part 1, part 2) how I wanted to try to buy as many Japanese net-nets as I could using John Templeton's experience as my guide.  My plan was to use Schwab, who at the time was offering free international stock trades.  My plan fell apart when it came to light that Schwab only offered Japanese large caps, they deem small caps too risky for investors apparently.

I was forced to revise my plan.  Because I was going to be paying full commission at Fidelity my position sizes would need to be larger.  To assist in my research I purchased The Japan Company Handbook, which is the Moody's manual for the Japanese market.  The book has a description of each company, historic financials and a number of metrics.  I took the stocks that were scored through the blog, and looked them up in the book.  I then plowed through all of the JASDAQ stocks while commuting to work and picked out the "best".

I was inundated with cheap companies, more than I had capital for.  I started to experience analysis paralysis, I couldn't decide which cheap companies were the best, or what "best" even meant.  Did I want better FCF yields, or a lower NCAV, or better dividends?  In the end I decided that I needed a sound system, one that could be followed and one that was simple.  I decided to buy stocks trading at 2/3 of NCAV, that were profitable, paid a dividend, and were stable companies.  The stable companies criteria is important, I can't tell you how many descriptions in the handbook read like this: "XYZ company was in marketing, now expanding to hotel and car wash ownership, also manufactures headlights, expects new ventures in concession vending."  A company with a description like that is a pass for me no matter how cheap they are.

When I last posted on the Japan companies there was a lot of discussion on whether I should hedge my Yen or not.  I don't have a large enough portfolio that any standard hedging would make sense (futures etc.)  I decided, well inertia decided that I would do nothing.  In hindsight a mistake, but then again if I knew the future I'd be investing differently altogether.

Since the end of November my net-nets have done extremely well, they've almost doubled in Yen terms, and gone up 62% in dollars.  I put together a small comparison spreadsheet showing other potential Japan investments denominated in USD across the same time period.  I even included the hedged Japan ETF as a way to show how the Yen impacted these holdings.

It's worth noting that I didn't start investing in Japan in November of 2012.  I've had a portfolio of net-nets over there for over two years now.  I wrote a Japan net-net retrospective on companies I'd written about last March, at the time those net-nets were up a median of 12.4% against a negative Topix.

Before anyone credits my investing acumen I want to clearly point out that I had nothing to do with these results.  I essentially randomly picked companies that fit my simple criteria and purchased them.  I never read any annual reports, or built any models.  I told myself that I would sell each company when it hit NCAV and recycle the funds into a new position.  I've recycled gains a number of times already.  The performance is my net-net portfolio as a whole, meaning I've had enough gains to offset the two -20% positions I'm still holding, and another -9% position I'm holding as well.

The conclusion from this is that investing in cheap companies works.  As a whole these companies have outperformed the market, and outperformed the currency depreciation.  Yes I could have made more if I hedged, but an argument could have been made just as easily that Japan and the Yen were dead and wouldn't be moving anywhere but up.  Of course everyone now claims they knew the Yen was going to crash, just like everyone claims they saw the housing bubble, or the dot-com bubble.

The quandary

As the Japanese market has heated up I've noticed something strange in my portfolio, most of my stocks will stay flat and then suddenly one will take off like a rocket.  I've had this four times now, it seems to be a weird market pattern.  A net-net will languish below NCAV, and then suddenly in a week or less rise to, or above NCAV on heavy volume.

In staying true to my investment philosophy in Japan I would sell once I realized the stock was trading for more than NCAV.  Recently though a friend was telling me about an experience he had with a Japanese net-net, the stock doubled and he sold it.  It then went on to triple, and eventually quadruple, in a very short timeframe.  During this time one of my holdings Zuken (6947) had taken it's turn to outperform.  The stock was limiting up nightly which is always exciting.

The stock raced past NCAV and I started to think about what to do next.  The problem was as I thought about selling I kept thinking about my friend's experience.  The thought crept in, "I wonder if Zuken will be a double or triple?"

I decided that I would research Zuken, and see if I could figure out why the company was appreciating, and determine a valuation independent of NCAV.  Lucky for me the company had an analyst covering them who said that their 3D printing technology was exciting and investors should wait until the stock hit book value to sell.  The mention of 3D printing further worked to implant the idea that maybe this lowly net-net I had was suddenly going to be a 10-bagger, or maybe even better!

I also found a presentation on the company's website where they discussed their current technology situation and plans for the future.  I don't read or speak any Japanese, leaving me at the mercy of Google Translate.  Unfortunately graphics heavy powerpoint is very hard to translate automatically.  I resorted to copying and pasting in characters a few at a time.

For all my work I came away with the understanding that Zuken believes their profits will double in three years, and that they are doing something with 3D printing in Germany.  The 3D printing seems exciting, although I'm not exactly sure what it is, or what it entails, but the market is happy with this news.

The research also confirmed why I'm investing in Japan by the numbers.  The language barrier is so high that I have trouble completing even enough basic research to be confident in an investment.  Google Translate is excellent at translating European languages, but stumbles badly on Asian languages.

After a few hours of futile Googling and translating I realized that holding Zuken for anything beyond NCAV was being speculative and greedy.  This was a company that had been valued as dead, and now was being lifted high on irrational optimism for their 3D technology.  The market swung from negative to positive so fast I almost missed the move altogether!

I decided to stick to my strategy and sold for more than NCAV, but at about 83% of book value.  I'm happy with my gain, and if the stock goes on to double or triple from here I won't regret selling.  I don't know enough to be confident in my holding, any gains I would have had from here would be purely luck.  I don't mind luck, but I also don't consider it a strategy.

Putting it together

After reading these stories the reasonable question to ask is "what next?"  I'm going to continue to do the same things I've been doing for the last two years in Japan.  I am going to recycle my gains into more net-nets, be patient, and sell when the companies reach NCAV.  I've had some readers ask me what I hold over there, I decided to post it here.  The companies are always in flux.  With the recent gains I'm expecting to add four or five new positions.  The following are my current positions:

If nothing else my experience in Japan has reinforced my experience with net-nets.  The companies are often lousy, and investors shun them, yet the courage to invest and be patient often pays well in the end.  

Talk to Nate

Disclosure: I own all the companies in the bottom spreadsheet.