Street Capitalist: Event Driven Value Investments

Jason Zweig’s latest column at the WSJ (Psyching Yourself Up to Let Losers Go ) tackles a tough issue for most investors - when to sell. Selling can be difficult for a variety of reasons, but a big factor is psychology. We don’t like to let go and give up things we’ve bought. Zweig provides us with a telling statistic:

Individual and professional investors alike struggle with selling. Berkeley finance professor Terrance Odean has found that investors are at least 50% more likely to sell their winners than their losers. Among the money managers surveyed by Cabot Research, a Boston consulting firm, fewer than 30% base their sell decisions on “extensive research.” The rest concede they basically sell by the seat of their pants.

To defend our portfolios from our emotions, Zweig offers us six techniques.

1. Use stop-loss orders

I’ve never been a fan of using a stop-loss order on a company’s stock. I know that Investors Business Daily advocates the use of selling whenever a company falls 10% and I think it’s too trivial of a rule. Zweig says that he doesn’t advocate the use of stop losses but prefers “stop look” orders:

Whenever a stock drops, say, 25% below what you paid, automatically review your original top three reasons for buying to see whether they are still valid. That will prevent you from selling without thinking first.

This is a pretty good idea. I practice the same kind of exercise myself. I don’t have any alerts set to tell me when about a drop of 25%, but I do check my company’s prices regularly. An easy way to get notified of drops in your companies can be done with Yahoo Alerts, you can get an e-mail or text message based up requirements you set (price drop/rise or percent drop/rise). Two of my holdings, Air Transport Services Group (NASDAQ: ATSG) and Steak N Shake (NYSE: SNS) have fallen a bit from my initial buying points ($1.70 and $10.00).

In each of these cases, I re-analyzed my investment thesis, to see if anything changed. With ATSG, the fall from $1.70 to below $1.00 was triggered by almost no news. DHL severing business ties with ATSG was already part of my investment idea- so I didn’t see a reason to sell. With SNS, my thesis hinged on Sardar Biglari getting onto the board and gaining control so that he could make the right decisions for the company. I decided that I would not sell till that thesis was properly tested.

2. Don’t Go Far Afield

Here, Zweig recommends buying an industry index if the company you purchased ends up having poor results. I don’t quite agree with this advice. It all seems a little bit like decisions made by an investor who doesn’t know what they’re doing who is trying to catch a trend (and may be too late).

The only time I think that this is valid is when you’re investing in an industry with good economics but where the individual players might be too hard to pick. I’m thinking of Buffett’s investments in pharma with companies like Sanofi Aventis (NYSE: SNY), GlaxoSmithKline (NYSE: GSK), and Johnson & Johnson (NYSE: JNJ). The difference with Buffett’s investments in pharmaceutical companies is that he still was not buying an ETF, he bought just a few of the players in that industry. An ETF will usually have many more holdings and carry the risk of over diversification.

3. Shop Before You Drop

Zweig’s next technique is a bit better-

Ask yourself: Which stock or fund would I most like to own? Then view your losers as a source of funding to reduce the amount of cash you would otherwise need to raise

Sometimes I think that selling losers can be good, especially if you’re purchasing a better buy. Maybe a new opportunity has presented itself with a higher return or the margin of safety in your losing investment has narrowed.

4. Re-price it.

Here, the idea is to take your original purchase price and divide it by 10 and compare that price with its current price. A simpler method might be to look at the price you’re seeing right now and compare it to your conservative estimate for the company’s margin of safety(the spread between the current price and the company’s intrinsic value you in your eyes). If you’re buying companies at what you think are 50% discounts, you’ll see a wider margin of safety. It will then be up to you to decide if anything has changed.

If the margin of safety has narrowed to a point where maybe the capital could be better used elsewhere, then you should.

5. Follow your sales.

This is some of the best advice in the column.

Using an online portfolio tracker, monitor the returns of all the stocks you sell after you sell them. Studying the aftermath of your mistakes will enable you to learn which you sold too soon and which too late. You cannot improve what you do not measure.

I try to do the same. On my Google Finance page I keep all of my stocks, even after selling them. I like to see what they’re currently doing and learn from my mistakes and the company’s mistakes. By doing this, you expand your circle of competence. It makes me think of a quote from Edward Lampert in Fortune Magazine.

[The] idea of anticipation is key to investing and to business generally. You can’t wait for an opportunity to become obvious. You have to think, “Here’s what other people and companies have done under certain circumstances. Now, under these new circumstances, how is this management likely to behave?” The plays my father designed for me helped me learn to think ahead. Lots of days I asked him, “Why can’t we just invite kids over and play a game?” In order to do something well, he explained, you have to keep practicing and preparing.

And I think that’s one of the more important concepts to keep in mind when investing. You can often draw upon past experiences when making future decisions. The situation might not be entirely the same, but it’s incredibly useful to have that kind of knowledge filed away for future reference.

It looks like one analyst seem to think so:

Analyst Steve West said in a note to investors that the company’s “long-awaited” strategic plan is due to be released in the next few months - a move that likely will improve sentiment in the stock and make for the beginnings of a turnaround.

West said he does not see traffic at the chain improving until at least 2009 “as the strategic plan will take time to implement and the consumer remains strained.”

But he said the company’s management is “taking the right steps for a fiscal year 2009 rebound.”

Although he said he does not know details of the plan, he expects it to include closing underperforming stores, cost-cutting, selling real estate, refranchising company-owned stores and repurchasing shares.

Steak n Shake shares rise on analyst report (IBJ)

I believe that one of the right steps was the sale-leaseback transaction Biglari executed recently. The move elicited a pretty negative response from some investors, but when faced with the possibility of bankruptcy since the company was/came close to violating debt covenants, it seemed like the right move.

Biglari’s withdrawal of the tax abatement plan appears to be the right move as well. Receiving that kind of support from the local government could have added to the costs of Steak N Shake (NYSE: SNS). These tax abatement plans are there typically for a business that is supporting and employing members of the community. They would discourage or possibly prohibit the closing of underperforming restaurants and firing of employees, which is just the sort of cost-cutting we might need right now.

Right now, controlling costs is at the forefront for most fast food and casual dining chains. It’s evident from the reports coming out that describe McDonald’s (NYSE:MCD) retooling of the double cheeseburger to make it less of a loss-leader and Burger King’s (NYSE:BK) hope of reducing the size of the Whopper Jr. to control costs. With most commodities going up, all of these companies are in a tough position. It’s an intensely competitive business, with your enemies usually operating next door. If you raise your prices to push your increasing costs to the consumer, you risk losing sales.

I’m still holding my shares, and believe that my previous estimate for the company’s valuation of $20 per share is still in tact, but I’m not entirely sure of how long it will take to play out. We’ve already seen the bankruptcies of Bennigans, Steak & Ale, and creditor pressure on Uno’s.

 

It’s likely that we’ll see more distress in this sector, just as some of the highly leveraged chains find themselves strangled by a perfect storm of debt, higher costs, and lower customer traffic. Shrewd capital allocation skills are going to be needed as the industry passes through this rough period, luckily our new CEO seems to have them.

One of the issues with Street Capitalist is that I don’t think take the time to really introduce new readers to value investing. This can be problematic with someone who is just learning about all of this and feels daunted by the task of somehow soaking it all up. I plan on doing some how-to’s in the future to help with this. For now though, I want to show you some investment cartoons I found from at Mirae Asset Financial Group.

Mirae is run by an investor named Park Hyeon Joo of Korea. I’m always fascinated at finding and learning about value investors who operate in different parts of the world - especially in Asia. Asia in particular is an interesting place for value or even long term investors. Mainly because the region as a whole has a reputation for overwhelmingly favoring short-term investing.

Here’s an excerpt from a Bloomberg article on Park:

The new firm caused a small stir in the business press because its offices didn’t include the wall-sized electronic stock ticker that graces most Korean brokerage offices. In his book, Park says his message to customers was: “Don’t sit around staring at the wall. Let professionals do your investing.” He reeled in clients by lowering the standard fee for stock purchases to 0.029 percent from 1 percent.

In a similar symbolic gesture, Park placed a clock with no hands at the entrance to Mirae Group’s Seoul headquarters — to signify to clients the importance of long-term investment.

Korea’s No. 1 Money Manager Says Genghis Khan Model for Funds (Bloomberg)

The Power of Inactivity

I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There’s no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.
- Warren Buffett

Circle of Competence

We don’t handle high-tech business because we have no talent in that area.
- Charlie Munger
There are all kinds of businesses that Charlie and I don’t understand, but that doesn’t cause us to stay up at night. It just means we go on to the next one, and that’s what the individual investor should do.
- Warren Buffett

Contrarianism

Invest at the point of maximum pessimism.
-John Templeton

We invest in stocks because stocks are plunging. Since we can buy stocks at a low rate in a bull market, I am nervous in a bull market. When stock market plunges, I’m happy. Crisis is a good opportunity. I know that more opportunities happen when business is dull and disaster & revolution break out.
-Mark Mobius

The quotes may not be anything new, but it’s nice to see the visual representations of these concepts, even in cartoons. They give you a simple way of conveying some often complex and hard to understand concepts and they’re pretty fun.

Here’s an excerpt from an interview with Nassim Taleb at Portfolio:

N.N.T.: A burning building is going to be a lot more anecdotal than a statement about what happened—and a statement about what happened is going to be a lot more anecdotal than statistics of what happens in the world to put it in context. To give you an idea, I go to Beirut all the time. If I watched television, I couldn’t—it would sort of convince me to not go. The risk of death is nothing, right? I mean, it’s minor compared to the risk of being killed in a car accident, you see?

L.G.: So statistically it’s more likely to have a car accident and injure yourself in a Westchester bedroom community than in—

N.N.T.: Than in Lebanon. Iraq is the only place where you’re vastly much more likely to get hurt or killed, but if you count how many people die every year in the States by car versus how many people die violent deaths in Lebanon, it’s minor.

World According to … Nassim Nicholas Taleb (Portfolio)

Taleb’s contrasting of anecdotal information versus factual information is important for investors. The news, especially on TV seems to have a habit of creating manias and panics. Just a week ago I witnessed this when my local news in Houston reported about “Hurricane” Edouard ,which turned out to be just a tropical storm. Instead of giving us credible information to make informed decisions (like the fact that most refineries in the Gulf of Mexico did not shut down) they bombarded us with footage from past hurricanes and gave out emergency precaution information.

Similarly, financial news outlets do the same thing. The minute-by-minute reporting of how the market moves only creates noise and clouds the judgement of investors. I don’t know if you have to turn off the news and stop reading newspapers like Taleb does, but you should know how to tune out and exploit it. The retail sector is a good example of this because they have to report same store sales on a monthly basis. The monthly reporting adds more noise to the market and makes retail more volatile than most. If you let the noise get to you, you’ll sell your positions out of fear because of the wide swings in a stock’s price that with missing one month’s same store sales estimates. But if you understand that the noise is often without merit, you’ll find that there are attractive buying opportunities created by these irrational movements.