The Lessons I Learned From Passing on RadioShack and M & F Worldwide

Many of the finest investment managers believe that their greatest mistakes are not bad picks, but rather missing out on the no-brainers that go on to produce huge returns because one was, as Charlie Munger might say, sucking his thumb. I’ve made some big mistakes of both commission and omission, but none has me kicking myself harder lately than two particular misses, one which would have earned me around 130%, and the other (this hurts) 450%+.

I’ve been debating for a while whether I should post about this, since it probably seems disingenuous of me to claim that I actually picked out the best performing stock of the year to date but “didn’t invest” (and have not blogged about it since these were picks from the pre-blog era, and have no cold-hard proof that I even looked at it save a few notes I took), but I decided the lesson to be learned is more important than whether someone reading this believes me, or not. So with that said, I understand if you think I’m full of it, but for those who are interested in learning from my costly error, read on.

What were the stocks? Well, the baby blunder (130% opportunity cost) is a well known electronic retail outlet called RadioShack (RSH) that when I was looking at it about a year ago was experiencing problems with same store sales, stiff competition from big box outlets, and on top of it all, had a CEO who lied about his college education and ultimately had to resign. The stock was pummeled to a dirt cheap price, but what I noticed looking at it was that it still generated heaps of cash and great returns on capital. When the company announced a restructuring plan, I figured that its still respectable store footprint, cash generation, and new leadership would make for a moderately easy improvement in the business, which would translate into huge returns on the stock given that it traded at what I considered 50% of its intrinsic value (something like 9X free cash for a multiple analysis).

I ultimately didn’t invest for two reasons:

I thought I didn’t know enough about the business’ restructuring plans or the new management to make an extremely confident decision. I felt that my chances were good (90%+ that this would make a great investment), but I wanted certainty where there was none.

I felt the price (then around $16/share) would drop more in the short-run due to investor worries. I was right (it fell to around $14/15-ish), but that was plainly stupid of me to think that way and I continued loafing, waiting to understand more about the plans and for the share price to drop. But it didn’t. It went up. And up. And up. And deservedly, I missed the boat.

RSH 1-yr chart:

The second and major blunder (450%) was a little licorice manufacturer with a relatively long history of throwing off cash in a boring business. I read the annual report, liked the simplicity and steady cash generation of the company, saw some decent growth potential, noticed a guy by the name of Ronald Perelman had been involved for some time, looked at the cheap price after using conservative inputs in my valuation and, then, sat on my behind. I felt I didn’t know the future of licorice (probably the dumbest thought I’ve ever had), and I thought the price would stagnate for a while I could take time to wait before I acted. What happened? Well, look at this chart of, you guessed it, M&F Worldwide (MFW).

MFW 1-yr chart:

So I’m substantially poorer than I could have been if I didn’t give up my thumb sucking habit. What’s the lesson, then? Simple, but not easy for many investors, and it’s something I’ve had to work very hard on:

You must be prepared to act quickly, and under conditions of imperfect information, or opportunities will pass you by.

There are diminishing marginal returns when you research product too thoroughly, since you don't have to be ultra-precise, or certain before making the plunge. Of course, I’m a believer in a focused portfolio, so one must be careful of foolish, large bets without doing homework. That’s what a margin of safety is for, and that’s why I look for the no-brainers. To get the big picture quickly, and understand that a competitive market often means returns don’t come to those who wait, is vitally important.

This may seem paradoxical to many value investors, since patience and thoroughness are at the core of the discipline. But we should distinguish between patience after making an investment and patience going into one. We’ll never be able to predict exactly when prices come in line with value, but it doesn’t matter so long as we first get into the stock quickly. This enables us to capture the returns on both sudden readjustments/catalysts and more slowly moving changes.

Thoroughness can also be accomplished without thumb-sucking. If you get the big picture, size up your risk and understand your probabilities, act quickly, and then continue learning the more minute details of the business after you’ve bought it, you’re probably better off than if you wait to understand minor details.

Comments

[FourBrane]

You seem to be saying that this company is in the licorice business, but that's not quite the case.

I missed the up rocket, but think there might be a down rocket. Here are my notes:

June 9: For a time I considered shorting this company, but after looking at it more closely I think it's simply impossible to figure. There are dead and dying industries mixed with others that are doing well (although for how long...?)

This company is classed as a "food processor," but that's just plain wrong. It's a messy conglomerate of stuff that doesn't belong together. You've got: a smallpox drug pharma, a licorice refiner, Hummer, the Panavision movie camera, a 35 mm film processing lab, Revlon, three different printers of bank checks, financial software, a big lottery ticket producer, the Scantron school grading systems, and an early-stage pharma with no products. What the hell is this thing? How do you figure it out?

Long term it looks over-priced at a PE of 38 for a bunch of disconnected trash and treasure, but it's at the bottom of its 3 and 6 month channels and could easily climb 10% over the next quarter. Plus, fighting the deep pockets of Ron Perelman is not my idea of a safe bet.

The Harland acquisition is underwhelming as this just gives them a bigger stake in a dying industry. Each year fewer checks are written as more of us move our money around electronically.