Friday, February 15, 2008

Introducing the Cheap Stocks 21 Net/Net Index: The First Index of Companies Trading Below Net Current Asset Value

We’ve designed what we believe to be the first index of companies trading below their net current asset value. The main purpose of this index will be to track a passive portfolio of net/nets. This index is chock full of small companies many of which have been beaten down, and some of which may not survive. We’ve developed this index primarily as an attempt to gauge net/net performance using a basket approach.

The Cheap Stocks 21 Net/Net Index is a market cap weighted index comprised of companies that met the following criteria at index inception on Tuesday, February 12th, 2008:

•Market Cap is below net current asset value, defined as:
Current Assets – Current Liabilities – all other long term liabilities (including preferred stock, and minority interest where applicable)

•Stock Price above $1.00 per share

•Companies have an operating business; acquisition companies were excluded

•Minimum average 100 day volume of at least 5000 shares (light we know, but welcome to the wonderful world of net/nets)

*Index constituents were selected by market cap. The index is comprised of the “largest” companies meeting the above criteria.

The Index is naïve in construction in that:

•It will be rebalanced annually, and companies no longer meeting the net/net criteria will remain in the index until annual rebalancing.

•Only bankruptcies, de-listings, or acquisitions will result in replacement

•Does not discriminate by industry weighting—some industries may have heavy weights.

Cheap Stocks 21 Net/Net Index Constituents and Weights (%, rounded):

Adaptec Inc(ADPT)18.72%
Computer Systems

Audiovox Corp(VOXX)12.20%

Trans World Entertainment(TWMC)7.58%
Retail-Music and Video

Finish Line Inc(FINL)6.30%

Nu Horizons Electronics(NUHC)5.76%
Electronics Wholesale

Richardson Electronics(RELL)5.09%
Electronics Wholesale

Pomeroy IT Solutions(PMRY)4.61%

Ditech Networks(DITC)4.31%
Communication Equip

Parlux Fragrances(PARL)3.92%
Personal Products

InFocus Corp(INFS)3.81%
Computer Peripherals

Renovis Inc(RNVS)3.80%

Leadis Technology Inc(LDIS)3.47%
Semiconductor-Integrated Circuits

Replidyne Inc(RDYN)3.31%

Tandy Brands Accessories Inc(TBAC)2.94%
Apparel, Footwear, Accessories

FSI International Inc(FSII)2.87%
Semiconductor Equip

Anadys Pharmaceuticals Inc(ANDS)2.49%

MediciNova Inc(MNOV)2.33%

Emerson Radio Corp(MSN)1.71%

Handleman Co(HDL)1.66%
Music- Wholesale

Chromcraft Revington Inc(CRC)1.62%

Charles & Colvard Ltd(CTHR)1.50%
Jewel Wholesale

The initial value of the Cheap Stocks Index was 100, as of the close on 2/11/08. Initially, we’ll report the index value on a weekly basis.

*The author does not have positions in any of the companies mentioned. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks
following the date of this post.


Anonymous said...

Was curious as to how the weights were chosen for the constituent stocks. For example, do you expect the higher weighted stocks to perform better ? Or any other rationale ?

Jonathan Heller, CFA, Editor said...

The index is market cap weighted; the "higher" market cap companies have more representation in the index.

TJF said...

Excellent idea clyde. Maybe a pink sheet index next??

Anonymous said...

Do you also track what is left for equity claim holders after one of these companies filed for Ch. 11.

Great idea anyway.

Anonymous said...

Will you be tracking the weighted discount to NCAV as well? It would be interesting to see how it fluctuates.

Capt. Castaway said...

Is there a way to "backtest" this index without a survivorship bias? That would be very interesting...

Anonymous said...

This is a terrific idea. The only other similar undertaking I can think of was the Oppenheimer study, but that was done over 20 years ago (and, I believe, was done retroactively).

Anonymous said...

Are these net/nets that meet the 2/3rds or less specification that Graham laid out?

Also, are intangible current assets factored into the calculation of a net/net. It was always my understanding that the point of a stock selling below it's NCAV is that the stock is selling for less than what the company's net current assets would fetch, were the enterprise to be liquidated. Thus, an intangible current would have no practical value.

I'd like to reiterate, though, that this is a great undertaking and it's great to see others who have a passion for this type of deep value investing.

Jonathan Heller, CFA, Editor said...

The net/net calculation ignores LT assets, so intangibles are not factored in. Calculation we use is less stringent then Graham's (we use NCAV, he used 2/3 of NCAV as threshhold)


Anonymous said...

Why don't you add AWX and KDE to the index?

Jonathan Heller, CFA, Editor said...

AWX and KDE, which we do own, do not meet the criteria necessary to be included in the Cheap Stocks 21 Net/Net Index. We do appreciate your suggestion and interest.