I like to think I’m aware of some of the biases that hurt investors: hindsight bias, consistency bias, anchoring, etc. Unfortunately being aware of biases doesn’t stop you from experiencing them.
Buffett compares investing to shopping for groceries: if you’re going to be a net buyer of groceries and stocks, you want prices to go down. I know it is fine if a cheap stock I own doesn’t move or gets even cheaper. Still, I have always found it difficult to hold stocks that don’t seem to move and that don’t have a “catalyst”. I think this is called action bias. You try to improve results by ignoring or switching out of stocks that aren’t moving into stocks that do have a catalyst. It has been one of the biggest leaks in my investment process and it has been difficult to plug. In the last year or so I do think I have gotten better at buying illiquid stocks without a catalyst. I can now often “force” myself to buy a small position in stocks that are so cheap that I think I have to own at least a little.
It has been an expensive lesson though, I have passed on many cheap, cash rich stocks without a catalyst that subsequently performed very well. I only began to notice my mistake when I started adding those stocks to my watchlist on Google Finance. From time to time one of these stocks did move significantly and the catalyst I thought wasn’t there just emerged one day. Talking to other investors has helped me to recognize this flaw as well.
One thing I realize now is that among value investors there’s is a large group of Buffett-style investors. They will invest in high quality companies and they run a concentrated portfolio. These investors will tend to despise deep value stocks without a catalyst, because buying a large position in them is a bad idea. Since you don’t know if a catalyst will emerge, let alone when, you should take a more diversified approach when investing in them. A lot of negative comments on forums and blogs about these deep value stocks are probably coming from investors using a style of investing that is not very suitable for these stocks. That’s not the stock’s fault though. These comments need to be discounted by investors using a more diversified approach, let’s call that approach the Schloss-style of investing.
I’m more of a Schloss-style investor than a Buffett-style investor. Most of the stocks discussed on this blog are illiquid, lacking a catalyst and in general are not great compounders.
Example: PNE Industries
A good example is a stock I wrote up almost a year ago PNE Industries, a Singapore listed net-net. For almost my entire holding period, PNE Industries has been a very boring stock to hold. The price barely moved and remained close to my purchase price of around S$0.085. At the time of investing there was no catalyst and the stock was very illiquid. However, it was also trading at just 0.42x book value and 0.56x NCAV, had more than half its market cap in cash and a solid history of profits and dividend payments. So I bought a little and nothing happened for a long time.
On April 28, the company announced results for the 6 month period ended March 31, 2014. PNE Industries showed S$3.0m in net income for the period versus S$2.0m last year. Book value is now S$71.9m and cash and bank balances have increased to S$18.6m. A positive surprise was the announcement of a S$0.005 interim dividend by the company. Last year the company did not pay an interim dividend, only a final dividend of S$0.004 which was paid in February 2014. A dividend of S$0.005 looks very small, but it is a 4.5% yield on the current stock price. If the company will continue to pay an interim and a final dividend of S$0.009 combined, that’s a 8.0% yield. They might be opportunistic about paying interim dividends though.
It was probably the announcement of the interim dividend that finally moved the shares from S$0.089 on April 28 to S$0.112 currently. A 25.8% move in a few days. With shares currently trading at 0.52x BV and 0.65x NCAV they still look very cheap to me.
It is a typical example of the type of stock I talked about in the first part of this post: illiquid, no catalyst, but very cheap. It can be frustrating to watch a stock like this languish in your portfolio. As a group these stocks tend to work out very well though, all the while offering great downside protection. I find it is best to simply buy cheap and not worry too much about catalysts.
Disclosure: long PNE Industries