PETS reported earnings this morning, and while their quarter beat expectations, their full year came in with EPS at .80/share vs .92 last year. The stock is selling off hard on the news – currently down 20% – although the stock was up 7.5% on Friday as short sellers rushed to cover their position before earnings.
At its late Friday price of $14 the stock was trading at ~17x its T12M earnings – by no means an “exuberant” level for an asset light company with a history of high returns on equity and share holder friendly actions, but it is hard to not kick myself for not taking some profits given that as of Friday my investment had returned 35%, and today it has returned 8%.
The long term investment thesis here is that veterinarians still control ~70% of the pet med market, and over time they are going to lose ground. Simply said, the vets are fragmented and won’t be able to compete on price (and convenience for OTC meds) with an online retailer. PETS has been under pressure as WMT and other brick and mortar retailers enter the space, and there are admittedly limited barriers to entry for other online aspirants. Margins will likely shrink over time, but even at lower margins the asset light business model will lead to high ROEs. This thesis is still intact, so I am not about to exit my position today – I feel comfortable with the long term investment here.
However, I think that this was a case where I should have ignored the part of me that likes the buy and hold / minimize transaction costs and I should have taken some off the table. In the first 3Qs of the year (they consider today’s earnings to be the close of the 2012 year) PETS had earned .22, .19, and .19 per share or a total of .60. In FY11 the company earned .92/share, so in order to just meet the year over year comparison the company needed a blow out quarter of .32/share. Now, it is not impossible for the company to have had a blow out quarter… they have historically been a consistent purchaser of their own stock reducing the denominator in the EPS equation, and the warm weather likely pulled some sales forward. However, there have only been a few occasions in their history where they have had EPS jump by more than .10 from quarter to quarter, and with a 35% profit in a short period of time, the risk reward equation favored taking a profit.
Similarly, KSWS has now become a round tripper for me and is currently sitting on my books as a loss while it was a 40% gain just 6 weeks ago. Again – I think the thesis here is intact – the company has brand value and a growing international business. For decades the company returned industry high ROEs with its “classic” white shoe, which has gone out of style over the last few years. However, all styles are cyclical and it is not hard to imagine the clean white sneaker coming back to some degree. I first bought this stock in December when tax loss selling had really beaten it down, and given that that was part of the thesis, I should have been quicker to take some profit.
Both of these situations have me thinking back to Mike Burry’s style of investing – which at times resembled “trading” more than investing. Burry had a rule that if a stock was up 50% in under a year he would sell half of his position. At the time, Burry was investing in a market that for the most part went up in a straight line with limited volatility. Investors today are investing in a more volatile range bound market where macro fears can over take value at any given time, and the investing public is apt to change their mind and dump stocks across the board on any given headline out of Europe.
Overall, I more prefer the buy and hold mentality due to the reduced transaction costs and tax benefits. However, there are shades of gray with everything, and in the 2 cases above, I think I should have leaned toward locking in the profits. When I buy a stock, I am typically buying it because I think that it will double within 5 years leading to a 15% annualized gain. If an investor can achieve 15% annual gains over any stretch of time he or she is part of a pretty respectable crowd.
Burry had a rule that required him to sell half a position if it moved up 50% in less than a year. In this more volatile market, I think it makes sense to sell half a position if it moves up 33% in less than half a year. If i am shooting for 15% a year over a long stretch of time, locking in 33% in six months equates to annualized gains of 66% which will go a long way toward reaching the 15% goal.
I think this rule also especially makes sense given the types of companies that I find myself interested in… in many cases they have high short interests as they are in the midst of some sort of turn around or temporary problem. In cases such as these the slightest bit of positive news can send the stock soaring as the weak handed shorts rush to cover, but turn arounds and temporary problems can take several quarters or even years to sort themselves out, so the shorts will likely be resetting their positions when the technicals appear to have evened out after the squeeze. This especially applies going into an event like earnings. Of course, if the earnings are better than expected, I will be kicking myself for having locked in the profit by reducing my stake, but again, it comes down to risk vs reward and not being greedy.
Food for thought next time I have a 33% gain inside of 6 months.