As it has been about a year since i first started to put some effort into tracking my thoughts on investing, I have been spending time thinking about investments I have made over the last year with a critical eye focused on improving my process and results and understanding what I have learned.
The first lesson that really jumps out to me is tied to RSH, which at down 76% from my purchase point as of today has been nothing short of a disaster investment. When I bought this company i was entirely too focused on the past record of high ROEs and a history of returning money to shareholders via buybacks and dividends and not nearly focused enough on the lack of a clear moat, increasing competition, and a shifting business mix toward lower margin products. On several occasions I thought about selling the stock, but my firm’s trading rules prevented me from doing so because we were actively involved in the name at the time. I was also emboldened by the fact that Francis Chou and other buy and hold investors had purchased stock.
I still own the stock because at this point it is a net net… sort of… and to be honest I still have faith in my original thesis that outside of major metropolitan areas where branded stores are common RSH’s all under one roof mobile business model makes sense. I am tempted to sell it just to get rid of it, but at these prices, I would probably buy it even w/o a clear moat. However, the lesson remains the same: FOCUS ON THE MOAT unless you are buying assets at a discount.
The second lesson that jumps out at me is my attraction to falling knife turn around situations such as RSH, KSWS, and EA. Each of these companies is cheap… but that is because they have all encountered serious changes in recent years and their businesses have seriously declined. I have found myself focusing too much on the past and not enough on changing environments. If they are able to just normalize their operations they will all do very well, however, these companies are not suffering from short term earnings misses or the like – they need to adjust their business models to regain their former strength – a process that may take years. There is nothing wrong with this, and I suspect that out of these 3 names two of them (not sure which too) will wind up as successful investments on a longer time line, but on a shorter time line, the falling knife situations are difficult to endure. As such I will have to pay more attention to position sizing and gradually enter positions of this nature rather than just picking spots.
The third lesson is the natural corollary of the second lesson, and that is rather than spending time on turnarounds, I should focus on companies that have a consistent record of 1) growing book value or 2) increasing their earnings power and operate in change resistant industries. More recent investments such as FLIR, WWE, and the cruise lines, are representative of this. Additionally, I recently purchased entry positions in GS and LUK. I am not going to go into my reasoning in depth, but short versions are:
GS – over the last 5 years CAGR of book value has been 10%, and current P/B is basically at the lowest levels since the depths of the crisis in 2008. Clearly the issue here is what does that book value consist of… suffice it to say that I am reasonably certain that the assets on the books now are of higher quality than they were a few years ago. ROE has come down over the last year partially due to declines in trading and banking volumes, but if you compare GS’s ROEs to their competitors ROEs, GS is lagging the group vs. the historical spread. This may be partially due to business mix, but I believe a large part of it is due to management being extra conservative. At some point management will reengage, capital markets will rebound, and the stock will enjoy serious multiple expansion coupled with the growth in book value in the interim period.
LUK – over the last 3 years book value has grown at a CAGR of 12%, and more importantly over the last 30 years book value has grown 20% per year. Without getting into details, this growth has often been choppy due to the vagaries of GAAP, but the longer term record is unimpeachable. Currently the stock trades at a discount to book as the market prices of several of their investments have suffered for various reasons and because the 2 founders are approaching the end of their careers (Ian Cumming has said he will retire in 2015 when he is 75 years old). However, this is a firm that for 30 years has taken the principals of value investing and successfully applied them. Their current investments are under performing (in terms of market price), but these investments were not made for short term reasons and will likely work out in the long run. Additionally, while the founders are clearly masters of their craft, I find it unlikely that they are not surrounded by extremely capable like minded individuals who will carry the flame long after the founding members are gone. As Buffett has said, “with value investing, you either get it in the first five minutes, or you never get it all.” After 30 years of running their business, I am reasonably certain that the folks at LUK have found plenty of people who got it in the first five minutes, and then spent the last 10 or 20 years perfecting their craft. At some point, the long term value of their present holdings will shine through, and in the mean time, new investments will continue to allow book value to grow. When the market applies an average multiple to this success, the investment will be a success.
The point is that these are companies in defensible industries that can grow their intrinsic value over time that are currently trading at cheap prices. The market price may get cheaper before it appreciates, but the core businesses are sound, and at some point in the future will ascribe a higher multiple to these strong businesses. As Buffet said, “I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.” However, unlike Buffett, I would be quick to take profits if multiples expanded to their historical average.
That brings me to the next lesson, which is to not be afraid to take profits when they come quickly. In the past year I have seen 4 of my investments go from 30-40% gainers to flat or losing positions without taking any off the table. I have collected dividends in the mean time, but I would be happy to at least have taken 50% of my investment off the table if it ran 33% percent in 3 months or matched some other arbitrary level of return. I am much more comfortable with a longer timeline and thus did not sell, but in a world of sideways markets, I will have to spend more time considering taking profits quickly if they come quickly.
In summary, this exercise has been a success in terms of forcing me to think about investments and document my process so that I can learn from it. Additionally, the many emails from readers have helped me think outside the box. There is much work to be done, and I wish that I was able to dedicate more time and resources to this forum, but it is serving its purpose to date.