Tuesday, August 28, 2012

Lessons Learned From Expecting Different Types Of Failure.

In what I think was one of my better posts, I talked of being contrary to the crowd of contrarians. This hits on a similar theme... part of growing as an investor is learning from the past- this is an example that has hit me recently that I thought appropriate to share.

It has been becoming more of worry to me that I have become so contrary that I immediately go against almost everything that other value investors say. Alone, this isn't bad, however, I feel that at times I am unable to totally make my own judgements on items that other value investors talk about first. Almost anything you hear will bias you. As an investor, it is your responsibility to recognize this and strive to make rational decisions. As part of this process, it has become evident to me that my best investments have been things that virtually no one else was in (or at least, talking about) or stocks where people repeatedly implied that my idea was a bad one due to lack of understanding the situation at hand. This has been both true in stocks and in my own real estate buying. With real estate, my best units on a cash flow basis are the ones that my bank doesn't like to lend on and sticks me with a refinance of 70% of the appraised value (which I thought was a lowball value in the first place) despite great margins and us having a great relationship. At times, I have questioned if I should alter my business model to accomodate what my bankers seem to want. Every time, the answer has implicitly been "no" as I don't want to do anything that makes me worse of a loan risk, even if my bank or their regulators don't get it. While I never really strayed too much with real estate, I did a touch with my stocks...

What sparked this post was my receiving an email from a reader, where in the course of conversation, he spoke of some of the trades that put him into the position of managing other people's money. To my surprise, one of them was a company called Charles & Colvard. I had previously thought that I was about the only person out there that had owned the stock (I previously wrote about not liking their memo/revenue recognition). In the course of emailing about the company and some other matters, I typed "CTHR turned out to be a home run for me. Something like 60 cents to $2.50 in a matter of months... I was WAAAAAY more lucky with that one that I have ever been good."

He responded with what was eerily almost the exact reasoning that I used for buying the stock: "You are the only value investor I've found who was also in CTHR.  I didn't find it until it had risen to $0.47 - but what happened was incredible.  As you know, they had $2.50/share in cash + gems, with basically no debt.  The new CEO came in with the share price around $0.60, and the Nasdaq was going to delist them if the share price stayed below $1.00 for another month.  So, they passed a share repurchase agreement - it was obvious that they were going to repurchase shares to push the price above $1.00 - and they had the cash to do it.  And, you could still buy shares for $0.80 even after the repurchase announcement!  I've still never seen anything like it.  It was almost a guaranteed 25% total return in 3 weeks - with very little risk.  Plus, there was the possibility of a decent business emerging."

A similar situation arose when I twice invested a decent bit of money in a regional airline called Express Jet. The first time, was a bet that was similar to my small but revolving SVU bet and was also an indirect speculation on declining oil prices, which promptly came close to doubling. Needless to say, anyone that is very familiar with how regional airlines generally preform, this bet turned out awful and ended with a huge loss. The second go around however, was based on a very similar premise to CTHR- despite being an airline, XJT was trading for something crazy like 1/10th of tangible book value- a whole lot of which was made up in cash. They were also purchasing back debt and buying stock to get their share price above a dollar due to a delisting notice... And they had more than enough cash to back it up. The first time, I lost a good bit of money- the second when I stuck with what I feel better doing, I made a good bit- actually getting back the money I had lost the first time, plus some.

As I stated at the beginning of this post, part of growing as an investor is learning from the past. If there is anything that I have learned, it is this: my favorite ideas have never been things like Supervalue or my first go around with XJT, where I figured if I made the bet enough times, I would win but fully expected to lose a few times in the process. I seem to do better with things that are super interesting to me due to cheapness and other factors- they often have a few catalysts as well, but that isn't a necessity. After all, it's important to really like your ideas as a contrarian, because you are generally implicitly saying when buying a falling knife "I am one of hundreds of millions, if not billions of people that could own this security... Out of all of them, I see something that makes me right whereas they are all wrong or missing something! Hopefully, I know more than the person who just sold me their fractional ownership of the company..."

A lot of my favorite ideas I have talked about on here; International Baler, Steak n' Shake, Syms, Farmer Brothers (long before the Barron's article), and to a degree, Charles & Colvard (to name a few). Others, I didn't talk about so much, as they were weird share repurchase stuff such as Phoenix Footwear was one of them or odd investments that I didn't think were really good for this blog- examples would be Carmart, Food Technology Services, or the previously mentioned Express Jet. They were all ideas where even if the company failed, I should be left with something or, likely a profit as a holder of the equity- Syms is a prime example of this, whereas is probably not the case if SVU fails.

Thankfully, I have remained diligent and weird speculative bets with a value tinge have been limited to a small percent of my portfolio and have been next to non-existent in the accounts that I manage- generally hovering in the mid to low single digits of the whole. But geeze, they sure seem to make up a larger amount based on the crazy toll they take on my psyche... Hell, it's probably the inversely proportional amount of news that said bets take up relative to my investment from where these bets are often associated with larger companies. There is just too damned much noise! It may be a form of reinforcement, but I honestly think that I "feel" more about Supervalu, whereas I "think" more about Sitestar despite having (literally) gotten part of Sitestar under my fingernails while doing some work on one of the company's houses.

Reading a ton of noisy news and other people's opinions makes you feel about things that are only meant to be rationally thought about.

As a hypothetical example of this, if Sitestar were to trade down by 50% in a day, I wouldn't care as I would probably be one of the people buying it. When SVU actually traded down by a similar amount when I was in Virginia getting ready to meet with Frank Erhartic of Sitestar, I got a weird feeling and was kind of frustrated despite what I was getting ready to do having much greater importance. The difference? SVU was complex in the wrong way, as it is and alway has been nothing more than an odds weighted bet. Sitestar on the other hand is a lot less complex once scuttlebutt is done and a feel for the future of the business is established. Does this mean that SVU is a bad bet at this point? No, I actually still hold on to some of it. Does it mean that Sitestar is a great one? Not necessarily, but I think so. However, it does mean that I know which one I would rather own when it comes to getting better sleep at night. This was also a cheap lesson for me, in that I learned a lot about my psyche without loosing very much money. Additionally, I may actually make some if SVU manages to get sold for a decent price. Regardless, I think I will end up winning in the end.

The bottom line? If I were a reader of this blog, I would expect for my future posts to get even more obscure- readership may dwindle, but I don't care (if I did, I would post about Wal-Mart, Microsoft, and Dell). I won't say that I will go to the lengths of Nate at Oddball Stocks for companies off the beaten track, but I am looking at companies with interesting balance sheets, income statements hide a lot of value, and yes, even some bankruptcies... I am almost sure that I am on a course that the market probably doesn't appreciate and that alone makes me froth at the mouth. Hopefully, it not only makes be better as an investor, makes money, and keeps me a bit saner. The beauty here, is that it also doesn't set me up to fail from day one due to my expectations that are built in to my brief soiree in "continuing bets" such as how I intended to do options and equity in SVU. Does this mean that I am permanently abandoning the idea? I probably won't completely, because I don't want the constraint; however, I will tread on these situations a lot more lightly in the future.

Best,

Jeff

Disclosure/Disclaimer: I own shares of SYMS, UWN, MPAD, SVU (and some options) and SYTE. I also own a fraction of a single share of IBAL that is owned by an investment partnership that I am a member of. I reserve the right to change my positions at any time. This post is my opinion. Always do a ton of your own research before even contemplating anything that I say, do, write, or so much as think about.


No comments: