Recency Bias And Capital Structure Mis-Allocation
Summary
- I share important lessons learned from mistakes made exhibiting Recency Bias and Capital Structure Mis-Allocation.
- Nautilus is the stock where I exhibited Recency Bias and it proved costly.
- I explain that had too much money in Range Resources' bonds and how that capped my upside to its dramatic stock rebound.
This is the third article from my learning from mistakes series. The goal for me is to share with readers my expensive cost of tuition in the form of mistakes (the direct cost from losses and opportunity costs).
For context, in case readers aren't aware, I published the first two articles, in this three part series in April 2020.
Enclosed below are the links to the first two pieces, in case you haven't read them and are intrigued.
- Radical Transparency And Confirmation Bias (April 9, 2020)
- Taking My Medicine (Losses) (April 29, 2020)
As I stated in the two prior pieces, my overarching goal and quest has to become a good investor. This goal has been my North Star and something that I have been striving towards since I started investing, back in high school (circa 1996). Lo and behold, given my inherently contrarian personality where I often question many things, sometimes quite critically, this has been a blessing and a curse. As an investor, critical thinking is an important skillset, but sometimes overthinking can be very costly.
Let me explain.
This year I have made two major mistakes. Let's start with my first and least costly mistake - Recency Bias.
Recency Bias
In 2020, on three occasions, I dipped my toe in the water on Nautilus, Inc. (NLS). Before I explain the trades and mistakes, let me briefly describe the company. Nautilus is a well known home fitness company founded in 1986. Readers might be familiar with its brands that include: Nautilus, Bowflex, Octane Fitness and Schwinn.
On January 17, 2019, the business inflected negatively when the company pre-announced horrible Q4 2018 results. The stock was then trading at $11.79 per share prior to the warning. SA's Carl Surran did a nice job of summarizing the miss.
On March 1, 2019, NLS's CEO, Bruce Cazenave, resigns.
On May 6th, the company reports disappointing results.
On June 24th, the company's CFO steps down.
On July 8th, industry veteran, Jim Barr IV is appointed CEO.
On October 24, 2019, this business shows up on my radar. I read a lot of news and synthesize a lot of information and this headline by SA's Clark Schultz caught my attention.
At that time, I quickly did some work on the company and dipped in water by purchasing a then 1% sized position at $1.58 per share. Within a few hours, I'm up quick 10.75% and I decided to kick it out at $1.75 per share so could do more work. I also was intentional that I wanted to wait to see earnings that were scheduled to be releases on November 7th (after the bell). So I made a note to follow up on November 7, 2019.
Source: Snapshot of my Fidelity account and closed NLS positions in 2019
Sure enough, after the bell on November 7th, NLS reported yet another weak quarter. Now, the conventional wisdom would say to simply avoid the stock as the turnaround appeared to have been failing. I viewed it slightly differently and still thought the company had potential, but needed to do more work. So I dabbled in the stock on two other occasions in 2019, making a few tiny trades.
As we entered 2020, Peloton Interactive, Inc. (PTON) become more of a battle ground stock with smart money longs and hedge shorts clashing. The smart money folks like Baillie Gifford & Co (33.3% stake) as well as Wellington Management (11.55% stake as of December 31, 2019) both long lots of PTON stock because they viewed it as a software business not a hardware business (that is my guess as I haven't spoken with anyone at Wellington or Bailie Gifford about Peloton). By the way, I believe that Baillie Gifford & Co. is one of the largest institutional holders of Tesla (TSLA) and they were in very early on the name.
On the short side, Citron put out a controversial short thesis and $5 price target on December 10, 2019. Incidentally, as of April 15, 2020, 51% of PTON's public float is sold short (17.62 million shares). The long vs. short battle wages on.
So given that NLS released a Pelotonesque bike at much lower price point, that has an electric screen that is open software compatible, so riders can connect to Peloton's software, I started comparing PTON's market capitalization with NLS's valuation. Now I fully get it that Peloton is a cult brand akin to a Tesla and that they control the valuable software that can be licensed. However, it was clear to me that shares of Nautilus were dirt cheap, sporting a market capitalization of less than $60 million (there are 29.8 million shares of NLS outstanding as of 2.21.20). So again, I dipped my toe in water. By March 24, 2020, Covid-19 is full blown on a global basis and people are trapped indoors with safe at home orders. Gyms are closed. Therefore, it doesn't take a rocket scientist to workout that this trend will benefit purveyors of home fitness equipment. So I bought a tiny 1,000 shares at $1.42 on March 24th. Lo and behold, the stock goes up 80% in a few days. Your muppet author (yup, guilty as charged) couldn't resist that 80% and decides to kick it out. I was also kicking myself so being such a wimp and only buying a 1% allocation. Now, at that time, my account was getting battered and my confidence was on the wane, at least temporarily. So this partly explains why modest sizing at 1%.
Source: Fidelity Closed Positions 2020
Fast forward to present day and NLS closed yesterday at $6.02 per share. Looks like I sold a wee tad too early.
Source: Seeking Alpha
Essentially, on April 8, 2020, Nautilus reported strong Q1 2020 sales. Since then, the stock hasn't looked back and has experienced escape velocity.
Of course we could discuss rear view mirror stuff like NLS's horrible direct sales revenue trajectory in 2019 and its declining gross margins in both its Direct and Retail segments, but who cares. After all stocks are about the future and Covid-19 was a huge positive catalyst for the brand.
Source: NLS 10-K
So my mistake was a classic example of Recency Bias. I did bunch of work on the company, I worked out the massive sales momentum and long tail winds for PTON as well as the massive disconnect between NLS and PTON's valuation even accounting for the fact that Peloton is a software company. We then got an unbelievable catalyst in the form of Covid-19 and I'm embarrassed to report I only made a tiny $1,447 dollar profit for all of that work. Because I was too focused on where the stock had been (and not where it was going) and how it was pinned under $2 for more than six months, that I dramatically under estimated the upside potential to a business turnaround. The market, however, didn't and the stock got re-rated.
The lesson for readers is that if you do all the work, have enough imagination to actually swing bat (maybe size it at 3%) and let your winner's run.
Capital Structure Mis-Allocation
As readers are well aware from my three Antero Resources (AR) pieces and two Range Resources (RRC) pieces, I was incredibly bullish on both stocks back in early April 2020.
Now the stars have aligned since my April 5th RRC article and April 7th AR (A 5 Bagger Or A Zero) article were published on SA. As an aside, I hope readers made a ton of money on both stocks.
Source: Yahoo Finance
Anyway, my mistake was that I had way too much of my capital in Range Resources bond and to a lesser extent Antero Resources bonds.
Remember, I started the year with a portfolio of $204,547, after making 20% in 2019 (with 50% in cash), and then watched my account get crushed. At the intra-day depths of early April 2020, I was briefly down 44.4%. However, by the end of April 2020, I staged a big comeback due in part to Antero and Range and finished only down 10.3% year to date through April 2020. As of yesterday's close, I am down 13.2% as my Macy's (M) bet, by far my largest, continues to melt.
Here is where I went wrong. I invested $35.5K in RRC bonds and had some stock in the account. However, I made the mistake of getting cute and I bought the most illiquid RRC 2022 bond (cusip: 75281AAN9). So because I had so much money tied up in RRC's bonds and these bonds are money good, but will take time to get back to the mid $90s, I was under sized, in this account (I do own a lot of RRC equity in my Buy and Hold account) RRC's equity. If I only allocated 30% of the $35.5K into RRC's equity on April 5th, at the time of my first RRC article, I would have done a lot better. Moreover, and although I made a modest profit, the opportunity cost was very, very expensive.
Because of this lack of liquidity, this bond (cusip: 75281AAN9) trades $5 to $8 points behind RRC's liquid 2022 bond (cusip: 75281AAY5).
Source: Fidelity
Next, last week, as I noted in Liar's Poker I bought back half of my Antero shares at $2.48. Well on Friday, May 1, 2020, I got cute and sold those shares at $2.94 because I bought 20 AR 5.125% 12/1/2022 bonds (cusip: 03674XAC0) at just over $0.69 on the dollar. Candidly, I got cute and incorrectly assumed that shorts would try to defend the line at $3. I figured that $3 per share was the shorts' firewall. Oops, yesterday, Antero's stock cut through $3, like a hot knife through butter.
I incorrectly figured that I could hang out in the bonds and ride them to $0.75 on the dollar then get a chance to buy back the stock in the mid $2.60s (totally muppetish and way too cute). Lo and behold, my buy order yesterday, at $2.65 missed yesterday's low by $0.03. Antero's stock rocketed yesterday to close at $3.34. Exasperated, as Antero's Q1 2020 conference call was excellent, I simply sold my AR bonds and have decided against bonds. At least for me, bond don't move enough for taste. I need the higher octane and liquidity of the stock.
Source: Fidelity
So of course, I made money in Antero Resources and Range Resources, on the equity side, but I left a lot of upside on the table as I had way too much money in the bonds and that large allocation caused me to throttle back my equity bet, as I didn't want to have more than 35% of my overall account absolute dollars in Antero Resources and Range Resources (bonds and equities).
Well, there you have it. My conscience is clear. I have shared my embarrassing Recency Bias and Capital Mis-allocation mistakes with the broader SA audience. I hope you will avoid making my mistakes by vicariously learning from me. Learning vicariously is the least expensive form of tuition.
This article was written by
I actively invest my own capital and for a few family members.
Favorite quotes:
“When you are inspired by some great purpose, some extraordinary project, all your thoughts break their bonds: Your mind transcends limitations, your consciousness expands in every direction, and you find yourself in a new, great and wonderful world. Dormant forces, faculties and talents become alive, and you discover yourself to be a greater person by far than you ever dreamed yourself to be.” (Author - Patanjali)
“Tentative efforts lead to tentative outcomes. Therefore, give yourself fully to your endeavors. Decide to construct your character through excellent actions and determine to pay the price of a worthy goal. The trials you encounter will introduce you to your strengths. Remain steadfast...and one day you will build something that endures: something worthy of your potential.” (Author - Epictetus)
"Hope sees the invisible, feels the intangible, and achieves the impossible." (Author - Unknown)
"When I stand before God at the end of my life, I would hope that I would not have a single bit of talent left, and could say, 'I used everything you gave me." (Author - Erma Bombeck)
Analyst’s Disclosure: I am/we are long AR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Also long RRC and M.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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