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Net Net Investors are The Knuckleball Pitchers of Value Investing

Another postseason in baseball is here, and Bob Gale, the writer/producer of Back to the Future II, swings but misses on his forecast for a 2015 Chicago Cubs World Series victory. I wouldn't take it too hard, Bob. Wall Street economists cannot even get next year's macroeconomic forecasts in the strike zone much less a correct prediction made in 1989 on who wins the World Series. Unlike economists who predict broad-based macroeconomic stats with mixed results, those who practice the craft of baseball focus on the minutiae. Pitchers in the big leagues obsess over every micro detail in their pitching motion, attempting to constantly improve upon it. A professional baseball player works on his own game, leaving the general topic of baseball to the sports pages.

The same micro versus macro mentality can be applied to successful stock investing. Famed value investor, Seth Klarman, made a comment in his now out-of-print book, Margin of Safety, that few people successfully predicate the macro view of the financial world. A recent academic study showed how even John Maynard Keynes, whose writings are the foundation of modern macroeconomics, improved his own disappointing investment performance by switching from a top-down macro approach to more bottom-up stock picking. Stock selection is to pitching as baseball is to the overall market. The former can be controlled by individual behavior, but the latter is out of one's control. Successful investors should be more like baseball pitchers, spending their productive hours focusing on the intricacies of the perfect pitching motion. An example of this micro rather than macro approach to the stock market comes from the teachings of Benjamin Graham, the father of value investing. For the more aggressive investor, Graham recommended purchasing stocks selling at a price point below liquidation value. These Net Net stocks, as they are called, trade at a price point below the current assets on a company's balance sheet after subtracting all liabilities, including preferred stock. Net Net stocks have been shown over the long run to outperform the overall market by a significant margin. In The Net Current Asset Value Approach to Stock Investing, Net Net stocks generate on average about double the return after transaction fees in comparison with a broad market index.

Investors who take an interest in this subset of value stocks have something in common with a small group of baseball pitchers who make a living throwing a unique pitch called the knuckleball. As with rare value gems classified as Net Net stocks, the knuckleball pitch is thrown in the Big Leagues by only a handful of oddball pitchers. As the baseball comes out of the pitcher's hand, the goal is to put as little spin upon it as possible. This type of pitch moves in an erratic fashion, forcing a catcher to wear an oversized mitt to successfully grab it as the ball crosses over home plate. A knuckleball pitcher keeps a good manicure set handy at all times, digging his optimally trimmed fingernails into the ball before releasing it at a snail's pace. This pitching motion contrasts with the typical big-league closer, who intimidates batters with fastballs routinely clocked at close to 100 miles per hour. As with the Net Net approach to stock selection, mastering control over a knuckleball pitch requires discipline and patience over the long haul. At times, these hurlers endure the wrath of baseball managers who behave as disgruntled clients when pitches end up far out of the strike zone. Net Net stock selection and knuckleball pitching can go out of favor at times, resulting in long periods of waiting in the dugout for another shot on the field to show your stuff. Famed knuckleball pitcher R.A. Dickey made $12 million this past season for the Toronto Blue Jays, taking his team to the postseason, almost beating the Kansas City Royals for a spot in the World Series. A rocky long career, Dickey tossed the knuckleball over home plate for five different major league teams in the past 15 seasons. Sitting idle on the bench for stretches at a time is not uncommon for Net Net investors as well. In a previous blog, I showed how the long-term superior performance of buying Net Net stocks can be achieved even when cash sits idle on the sidelines at times. Waiting patiently for the "fat pitch" when Net Net stocks once again bubble up to the surface is part of the game when it comes to this value investment methodology.

Major league pitchers hurling fastballs and curves over home plate can wear out their arms, shortening their professional careers due to injury. Knuckleball pitchers who are successful in the big leagues can stick around for a long time. The knuckleball pitch moves at about 60 to 75 miles per hour, far slower than the typical heat thrown by pitchers at that level. The stately pace of a knuckleball pitch keeps the wear and tear on a pitching arm to a minimum, enabling these out-of-the-mainstream hurlers to extend their careers. Phil Niekro threw a knuckleball pitch for 20 seasons in the big leagues, retiring from baseball at the age of 48. Net Net investors can learn from knuckleball pitchers on how to be successful in the stock market over the long term. At times, the Net Net approach to investing goes out of favor and lags a broad market index. Those temporary setbacks are par for the course for not only value investors but also knuckleball pitchers who temporarily lose control of their Money Pitch. Pitchers who master the knuckleball can enjoy long careers in the big leagues when compared to other more mainstream hurlers, who wear out their arms at a faster pace. Waiting for the right Net Net pitch to come your way is better than swinging for the fences at every newfangled investment fad that makes its way to the front of the list.

Baseball hurlers who sustain potential career-ending injuries often consider the knuckleball in their pitching arsenals as a way to potentially extend their professional careers. Switching gears and moving to a slower moving pitch is easier on the pitcher's throwing arm, but it is hard to master. Losing pitch control of a knuckleball can lead to doubt in the mind of a struggling pitcher eager to include it in his arsenal in an attempt to revitalize his career. Continuing to throw a knuckleball requires psychological discipline, especially when managers are tossing you under the bus every time the pitch dips out of the strike zone for a few starts on the mound. As with periodic bouts of disappointment among knuckleball pitchers, over the 60-year period of 1951-2009, a pure Net Net stock portfolio underperformed the broad market index 42% of the time. This disappointment in no way resulted in underperformance over the long haul. A stretch of innings where the Net Net portfolio underperforms a broad market index is like a temporary loss of pitch control. It is part of the game and should be accepted.

According to baseball-refence.com, over the past 110 seasons, a total of 29 pitchers have used the knuckleball as their primary weapon against major league sluggers. A statistic used to measure a pitcher's effectiveness is called the earned run average (ERA). It is calculated by taking the average number of earned runs scored against the pitcher in every nine innings pitched. The lower the ERA, the better the pitcher. The table below shows the average ERA of each knuckleball pitcher over his professional baseball career.

Knuckleball Pitchers versus Net Net Stocks over Length of Pitcher's Career

* Net Net Average Annual Return calculations over a pitcher's career include dividends and transaction fees in all of the calculations. No more than 10% was invested in any one stock. Years when fewer than 10 stocks could be found meeting the Net Net criterion, the balance was invested in United States (U.S.) Treasury Bills. For a pitcher who started his career before the year 1951, the average annual return on the Net Net portfolio assumed a 1951 starting date.

These out-of-the-box knuckleball pitchers have produced a median ERA of 3.64. That performance metric of knuckleball hurlers was better than the average ERA of a pitcher in Major League Baseball in the 2015 regular season. As indicated in the table, Net Net average annual stock returns never lost money over the equivalent career length of each knuckleball pitcher who made the list. The only exception is Charlie Zink. He pitched only one game for the Boston Red Sox in the year 2008, a lousy year for Net Net stocks as well as knuckleball pitchers.

Investors in the stock market can learn a thing or two from this special group of professional baseball pitchers who chose a road less traveled in the big leagues. Investors who maintain the discipline of a knuckleball pitcher by embracing a somewhat unorthodox approach in their investment methodologies can also produce above-average results over the length of time they choose to remain active in the markets.


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