How To Build ( And Run ) A Garbage Portfolio

In my time as an active investor I have discovered many, many things that do not work for me...and a few things that do. There are often arguments that rage on Twitter and other investing forums such as: Investing in a growing business versus focusing more on valuation or Emphasis on quality of management versus simply taking a statistical approach or my personal favorite...Taking a purely fundamental approach versus using technicals. All these are valid arguments, mind you, but I think what is far more important than focusing on any single aspect of investing is finding the style that works for your brain and temperament and personality. Some of the greatest traders in the world with long term track records in the 100% annualized range focused on things like trend following, using leverage and stop losses to great effect. But none of that matters if I can't make it click with me and practically apply it. Other investors ( whom I will leave unnamed ) have become household names by identifying strong businesses that stand the test of time and simply sitting on them and reaping the rewards.

My point is: there's a million ways to make money in the markets, but you need to find YOUR way. You need to know your process and know what works for YOU. And it may be a weird strategy, that seems to go against basic mantras and principles you have heard for years, but if you are repeatedly winning by using a similar process over and over again...why would you change that? Unless, of course, it stops working. Well, today, I'm going to talk about my process and my strategy. You probably all know by now that I'm a huge fan of net nets and devote most of my investing time in that space, but there's so much more to it than that. And I'm going to take you through my step by step process so that you can potentially get ahead in the game instead of fumbling around and losing money for the first few years like I did initially.

DISCLAIMER. This is not investment advice. This is just what has been working for me, personally, over the past few years. I don't have a long, or insanely high return track record. Since summer 2022 when I started doing net nets I've been averaging about 34% a year and I'm continually refining my process. Maybe later on I'll find something that works better or maybe I'll have so much success in this space that I out scale it. Who knows? I just want to share what I have found to be helpful. So take it with a grain of salt and DYOD! With that being said.

Step 1: Idea Generation.

I tend not to use screeners or rely overly much on alerts, because both screeners and alerts tend to miss the really interesting stuff and will pick up things like biotech, Chinese reverse mergers and things of that nature. I find, instead, it's much more helpful to surf Substack, Twitter and Reddit and typically I can read the entire pitch right there on the app or website. Most of what I'm looking for is just major mispricing on an asset basis. So when I see key words or terms like NCAV or Net Net I get really excited. Anytime I see a ticker that even moderately interests me I immediately go to my Webull app and punch in the ticker to keep it in my watchlist. For those who don't know, Webull is a retail trader friendly app with an incredibly intuitive user interface and an easy to add watchlist that automatically gives you news and updates on each name. The brokerage is quite limited on what names you can actually trade, but I find it's my go to for quick research purposes. I regular get up to 500 names in my watchlist and have to go through and delete a bunch for sake of keeping track of everything, but again, it works perfectly for idea generation. The other place I receive ideas from is directly from the SEC filings website. When searching there I'm primarily looking for tender offers, which I used to be extremely active in. Not so much anymore, but I still like to keep track of them and you can find them by going to "Latest Filings" and using key word searches SC TO-I, SC TO-T, SC TO-C depending on which category of tender offer it is.

Step 2: Valuation

Now, my time is important, and investing is not my full time job, so I have to minimize time spent wherever I can. Therefore, typically, when I'm doing valuations I have the process cut down to the absolute bare bones. Remember that I'm looking for a substantial discount to Net Current Asset Value...primarily in just cash or accounts receivables. Wall Street journal’s free stock research Page is typically quite accurate and easy to use for just trying to find basic information in the balance sheet. My basic internet search when trying to find info on a stock is "ticker balance sheet" and Wall Street Journal will typically pop up. There you can find a 5 yr track record of balance sheet, income and cash flow statements. The first thing I look at is most recent quarter balance sheet. At the top is normally cash and cash equivalents. I use the full value of the given figure. Next I add accounts receivables, again using the full number for the value.

Normally those are the only balance sheet categories I care about. Depending on the scenario I may consider inventory ( although I'll still normally only value the inventory at 50% ) and I'm finding more and more frequently that further down the balance sheet list there may be things like "Investments" or "Marketable Securities" These will typically be portfolios of stocks or perhaps an interest bearing loan. I value these at whatever the given figure is. Although I do typically like to track down the loan book or stock portfolio to make sure it's not absolute garbage...even though being garbage rarely keeps me from buying.

After I've added all the applicable current assets I subtract ALL LIABILITIES from the number above. The harsh truth is that when buying something purely off an asset basis you need to drastically undercut the upside valuation and assume the worst on the downside.

Whatever figure the current applicable assets minus total liabilities gives me is my fair value of the company. But the problem is I don't want fair...I want outrageously cheap. I want downside protection layered upon downside protection etc etc. I will compare my fair value number to the total price of the market cap...and if the market cap is above my fair value price it's an almost automatic no. I'm looking for companies who's market cap is trading at HALF of my fair value price. That's how unreasonable I want my discount to be. But, as always, there are exceptions and extenuating circumstances so allow me to further explain myself.

Step 3. Total Wipeout Risk Analysis

The worse a company is the bigger I need my discount to be. If I'm buying something extremely sketchy or known to burn cash I need some assurance that the cash will probably take a few years to burn through therefore giving time for a price correction and/or new developments. This doesn't always happen, but it is always the goal. The timeframe that I'm comfortable with sitting on any given stock is about two years. Two years is typically enough time to figure out whether or not a company is a hopeless basket case or whether they're actually trying to improve operations...or sometimes just the price spikes and you sell without asking questions...this is not an exact science. So when deciding which net nets I actually want to let into my portfolio I like to make sure that the cash on hand can cover a two year burn rate at historical average. This is not a perfect measure, but it works fine on average. Preferably the company has real profits and revenues and I don't have to worry about burn rate at all, but that is simply not always the case and so I will do a comparison of these two different cases. When doing risk analysis on net nets you either A. Assume the burn rate keeps going and hope for operational improvement and/or a price spike before the cash on the balance sheet runs out. Or B. Buy a real company with several years worth of revenue and profits and take a much less aggressive stance on valuation. If I'm going with option B ( which, admittedly, feels much more like real investing ) I am actually concerned with the business as a going concern to a degree and so might buy something trading around my fair value figure, although a large discount is always preferable. But if I see 5 yr track records of revenue growth and buybacks and growth of shareholders equity then buying AT fair value as opposed to drastically less than fair value can be acceptable. As with all things the more risk involved the bigger discount I require. Eventually you learn to sort've feel these things out. After all, you can't buy every net net you find...or maybe you can. That would be an interesting test.

Step 4: Cross Referencing

Once I've concluded that a stock is cheap enough for me and probably NOT going to go to zero within two years I will cross reference between multiple sites that provide financial statements to make sure none of the figures are screwy. In addition to Wall Street Journal I will use Yahoo Finance, Barrons, OTC Markets ( when applicable ) and, of course, the actual company website. If you use five different sources and come to roughly the same figures everytime than you can be reasonably assured that the figures are most likely accurate. But don't get too hopeful, we are still buying garbage here. Occasionally I'll search for more write ups on the company just to see what other people have to say, but, quite frankly, I don't much care what other people have to say about the companies I buy. I say this, not out of arrogance, for there are many better investors than I, but out of the knowledge that, in order to gain alpha I have to be trading outside the box. Therefore I will normally be buying securities that either people don't know, have given up on or won't touch with a ten foot pole.

Step 5: Technical Analysis

People in the value investing space say technical analysis like it's a dirty word, but it's actually awesome. However, I think I need to clear up some misconceptions about what technical analysis is and what I use it for. The way that I see it technical analysis is simply a snapshot at any given time about the mass perception of a given issue. It is not magic. It is not foresight. It is not perfect by any means. It is simply one way to ascertain the probability of the direction of a public security over the course of a given time. It's just another probability. And I don't know about you, but the more probabilities I can layer on each other whilst investing makes me confident that, on average, I will be directionally right overtime.

And I get it, it's fun to hate on, but it was good enough for Michael Burry and Peter Lynch so it's good enough for me. For all you naysayers. I encourage you to take a pool of ten stocks. Use fundamental analysis on 5 of them and look at a long term chart for the other 5 and then keep track over what happens in the stock price the next few years. You will be shocked. The charts don't replace the work that I do fundamentally, but they certainly encance it. And I'm using charts in the most basic, brainless way imaginable. So, what's the one thing we all want from our stocks? Why, we want them to go up over time. And if you don't, then why are you even investing? Now, fundamental analysis is great for choosing WHAT we want to buy...but it does a rather poor job of telling us WHEN to buy. The problem is most stocks that are cheap will only get cheaper and most stocks that are expensive will only get more expensive. This is completely relative, mind you, but the point I'm making is if a stock has a straight line down and to the right...chances are in the next few months it's going to keep going down. If a stock has a straight line up and towards the right? Chances are it'll keep going up. Momentum and mass psychology are very real and charts are excellent predictors of the current direction a stock is headed in. I simply like to use the basic charts on Google where they show you snapshots of daily, monthly, yearly, 5 year and Max. The daily and monthly don't typically help too much, but if you find a stock has traded flat for 5-7 years in the chart and then 2 years ago it started trading steeply upwards there is a high probability it will continue to trade upwards for a few more years. This is an ideal situation as the stock has been left for dead and no one seems very interested, so you can accumulate large portions over time without much worry of it snapping off in either direction. I will admit I don't see this all too often, but I saw such a pattern in both $GNW and $LGL and although I initially bought based off of fundamental analysis I continue to buy based off the charts. I have bought upwards over the years and both positions are roughly doubles...AFTER averaging up significantly.

More importantly, charts can keep you from entering a position too early. This happens to value investors all too often, we see a stock we like, we do our fundamental work and realize it's cheap so we run out and buy it. Then wait years for it to do nothing ... Or worse: crash out on us only to price correct after we've sold it. It's much better to be able to get your timing right. I mean 100% gain in 1 year is statistically always better than 100% gain in 3 years. So before rushing out to buy something I want I take a look at the chart and try to make sure it has a good year or two of positive upwards momentum behind it. Almost every time I don't do this my position continues plummeting and I'm left there feeling dumb. Use the charts my good people. You will find it drastically increases your stock position entry accuracy. People like to use the phrase "I hope my stock goes down so I can buy more" but I think they're just coping, because I can tell you from experience that watching your stock go up actually feels much better.

Step 6: Buying

This section will hopefully be pretty short, but there are a few things that I wish people had told me initially that will save you a lot of headaches early on. First of all, always use a limit order. When investing in net nets you will mostly be looking at market caps of under 50 million, sometimes as small as in the hundreds of thousands...and let me tell you...things behave very differently at that level. The bid/ask spread can literally be a difference of 0.01 and 0.1, in fact, this is pretty normal. Wouldn't you hate to value a company and decide it was time to buy it, only to place a market order and buy it for 10 times what you valued it at? Conversely, if selling, wouldn't you hate to sell said stock at a tenth of what you want to sell it for? When playing in the big market caps you don't really have to worry about such things, but limit orders are your best friend here in nano cap land. Also keep track of volume and frequently check the bid/ask spread to exploit it. The volume of a stock simply means how many shares are trading at any one time. Alot of the stocks I own will have zero volume on any given day. Frequently when I buy or sell I am the entire daily volume in the security. But you can use this to your advantage. When looking at the bid/ask remember that the bid price is the highest price a buyer is willing to pay for a share while the ask price is the lowest price the seller is willing to let go of his share for. So if you're trying to gain entry into the stock and don't want to wait you can simply place a limit order at an increment above the current ask price. This will trigger a buy ( assuming there's volume available ) but at the lowest price currently available. If I want to buy a stock and the bid/ ask is 0.223/0.281, assuming I feel that 28 cents is a fair price for the stock I would set a limit order at 0.282. This may seem obvious and silly to point out, but every incremental gain is still a gain and you might as well take advantage of that. More on this later when it comes to selling. Lastly, whatever position size I think I want for a given security I'll normally start out buying only half that size ( if I can get any volume at all ) That way if I got the timing wrong I can still average down if I really want to, without blowing all my money on a bloated, losing position. And if it shoots up before I establish a full position and runs away from me? Well often this is a good sign of momentum and I should make my full position as I buy up OR if it's just a random price spike I can always take the gains on a half position...better that than no gains at all. Once I've established a full position I will frequently put half the position on a good 'til canceled limit sell order for twice of what I bought it for. Several times in the past this has triggered within weeks and I made an easy double within a short time span. At that point you can decide whether or not you want to keep the half stub or just sell out completely.

Step 7: Position Sizing and Diversification

When it comes to garbage investing you need to be diversified because all the stuff they say about melting ice cubes does have *some* merit. But, the important thing to note here is that the rewards of a melting ice cube is completely relative to a given timeframe. If you buy a stock based off the premise that it's trading at half of its net cash value then there's a good chance that in five years all that cash will be gone and the stock worthless, but that's looking at it from the wrong time frame. Often the value of a net net is realized much, much sooner and the price corrects long before the cash is depleted. That being said, it's impossible to know ahead of time, and if you only buy two or three net nets...well those may be the two or three that don't work out, but if you buy twenty or so of these stocks, then, on average, they tend to work out quite well. However, I don't necessarily want to own every stock under the sun either and there is a limited pool of net nets out there, so I don't know exactly what the right number of stocks to own is, but for me I don't typically like holding less than 15 stocks. However I recognize the incremental benefits of concentration, so I typically find less than 30 stocks is a good number that allows me to keep track of my portfolio and keep up on the daily news for each name.

Now in that pool of 15-30 stocks I have 3 different categories that have formed naturally and I find that there's always something to buy in at least one of those categories so I'm virtually always fully invested because I have decently high turnover. This also happens naturally.

My first category is what I call my "Secret Stocks" and at any given time I might hold about 10 of these at a 5% position each, in total making up about half my portfolio. These will typically be OTC listings and very small, very illiquid names. They are typically alright businesses with very high insider ownership and there's nothing inherently wrong there, just nobody knows about them...or if they do know about them they don't care and/or the names are too small/illiquid. Whatever the reason is if I find a 10 million dollar market cap co that has consistent profits and is growing shareholder equity over time, but also trading at net cash that's normally a buy right there. The illiquidity is the key thing here and it's not unusual for these stocks to sit and do nothing for years only to double...or sometimes fall 50% over night based on nothing. The goal, however, is simply to have a basket of these cheap, illiquid stocks and wait for them to reach some sort of premium to their cash value. Normally a double in a few years is totally acceptable. What can be interesting though is when liquidity kicks in and you get some volume on these names they can shoot up really fast and really severely. So one must be patient because you never know if or when they will have that happen, but in the meantime the company's normally buying back their own stock or giving a small dividend. It can take awhile to gain a good size position in these because they are so illiquid, but that's also why the opportunity exists and if they work out and the volume and liquidity starts increasing they become much easier to exit. Now something I do to provide a little extra gain to my portfolio is if my position has risen just slightly above my cost average I will check the bid/ask spread and, as I've said before, sometimes the spread is massive. If you do a limit sell order just slightly above the bid you're guaranteed ( volume permitting ) to get that sale price, but if you sell off some here and there in small lots sometimes the stock will sell closer to the ask price, which could result in a lot more money. It is a bit of a gamble as to where the order will actually fill, but worst case scenario...you still made a slight gain. It is a bit of extra work and not really necessary, but I find it adds a few percent in gains to trade around the position like this.

My second category is my "Mainstay Stocks". These ones are very unusual in that I'm willing to concentrate much heavier in these and don't even require them being net nets, just very statistically cheap. I absolutely love when I see a mainstream listed stock trading at 1 PE, 0.1 PB, 1 EV/FCF, 0.1 PR...things like that. I like it when these stocks are so hated and left for dead that no one believes they can possibly recover. If they're a net net that's a huge bonus, but again, not required. Believe it or not one of the main drivers in picking these types of securities is momentum coming off of an all-time low. If there's a company with low chances of bankruptcy, decent volume for institutions to pile in and a solid year or two of upwards momentum behind it that's already very promising. But, of course, I also want to buy it when it's statistically cheap. Finding that statistically cheap stock with a flat 5-7 years and THEN 1-2 years of upward momentum as evidenced by the chart is quite rare, but such a strong sign of a prolonged upwards movement in the stock price. I'm quite comfortable placing 10%-20% of my active port ( sometimes more for a brief while ) into a single one of these names if the conditions are right because it's a killer combination of a statistically cheap stock with momentum. That's somewhat rare, but such a phenomenal combination and is constantly reinforced by first the chart...and then good company news. These stocks are essentially your classic turnarounds, but the difference is these ones have already started turning around. You do NOT want to be stuck in a turnaround stock that never turns, but that's why the momentum and charts are so key here. When you're lucky enough to find these stocks with the perfect combo you should be willing to buy up along the way. And you'll find that good news will frequently confirm and reconfirm that these are good buys. Unfortunately I can only find one of these every few years, but I typically hold these ones for quite sometime, as of right now I'm holding only two stocks that definitively fit this category. But there are a few others that could eventually fall into this category overtime.

My third and final category is the "YOLO stock". I also just refer to these as my "Flyers" and it's exactly what it sounds like. It could be a biotech net net, or a China reverse merger or any number of sketchy and risky plays that I consider less an investment and more of a trade. I started this category because I kept seeing big, popular names like $CDLX and $NVDA just keep spiking up and up with no reprieve, thinking to myself, "I'd like to get in on that, but I can't because I'm a value investor" and then the stock would go way up and I'd feel sorry for myself. Well, boo frickin' hoo. Maybe the real lesson of this whole article is how not to shoot yourself in the leg. NEWSLASH, we don't receive extra investing points for being dogmatic. If you want to buy some Bitcoin or that really sketchy, maybe fraudulent company you don't understand than go for it! In very...very...small quantities. We tend to have this strange, pre conceived notion that in order to buy anything we have to know it inside and out and, that's a dumb, self imposed rule. I'm not saying go out and just gamble all your money away, what I'm saying is it's okay to do this with just a little bit of your money. And sometimes, you then realize that it could actually be a good investment. The other good part about allocating a small portion of your book to small trades is that maybe sometimes you're curious about a security and in order to build conviction on it you have to first own a single share to simply track it and that is what forces you to understand it. Anytime there's a name that I'm simply trading based off of momentum or something with so much hair that I think there's high likely hood of bankruptcy I just buy a little bit and see what happens. And, on average, it tends to work out pretty well! Frequently I will have 10% of my portfolio spread across 10 different "flyers" or YOLO stocks and, sure, a few of them either go to zero or get cut in half. But alot of them will pop off 20%-30% in the after market and I'll sellout. Sometimes I'll even get a quick double out of these! I frequently will put tender offers into this category as well, simply because, for me, I'm buying just because of the arbitrage and wouldn't want to hold onto the business after the deal goes through ( or in some cases falls apart ) Probably the best use case for this category is the aforementioned "momentum capture" where I don't really know anything about the actual business, but the momentum is crazy good! I have almost never gone wrong putting just a percent or two into these names and riding the wave for a little bit. Just remember that this last category isn't really investing. It's fun...and often profitable, but it is most definitely not investing. So, size them small! Also, probably better to try to capture momentum to the upside instead of buying into something that just dropped 90% in a day and hoping for a bounce back. It can still happen, but odds are if the stock is going up...it tends to keep going up. If a stock is going down it tends to keep going down

Step 8. Selling

We all know that selling is the hardest part of investing and I don't have much to say here as I don't want to be redundant and, honestly, I'm still figuring it out. But my go to rules are #1. If your position goes down 50% you should probably sell. #2. If your position doubles and/or reaches book value you should probably sell. #3. If the business is actually improving overtime and hitting goals previously set by management you should check the charts and, if there's solid long term upwards momentum in the stock, consider buying more.

That's about all I have to say for now. I'm aware that was a lot of info and maybe I expressed some seemingly contradictory or divergent views, but these are just the things I'm finding to be true for me. It may not work for you or you may dissagree with some stuff and that's okay. It's all about establishing a good process that works for YOU. Whatever the case I hope you gleaned at least a little bit of insight from my ramblings about Investing, Trading and, in some cases, Gambling. Take everything with a grain of salt, we're all just learning and evolving with every trade. With that being said, may the odds be ever in your favor and until next time...happy hunting!