Tuesday, September 11, 2012

DF Spinoff, Mr. Market, When to Sell etc.

So it's been a while since I posted.  Some late summer, beginning of the school-year business, some laziness and some dead-ends is my excuse. 

Dean Foods / WhiteWave Foods Spinoff
I spent some time digging into the Dean Foods (DF) WhiteWave spinoff but couldn't get over the fact that it just looks like a really crappy business.  Sure, sales have been growing at WhiteWave in double-digits which is rare in the food industry, but their operating margins is in the high single digits; much lower than other branded goods.  It was hard for me to give it a high multiple which would be needed to make this an interesting sum-of-the-parts/spinoff play.

Maybe WhiteWave after the spin improves operations and gets their margins up, but they didn't really indicate that on their recent conference call.  I think they have said in the past that high single digits is the normalized operating margin they expect over time at WhiteWave and when an analyst asked if that is still the case in a post-spin-announcement conference call, they said they don't want to comment on that now.  So my take is, why would it change after the spin?

Looking around in stores, I wonder what the moat is in the WhiteWave business.  Most of the brands are relatively new, and I think that it's the concept of non-dairy milk that is the attraction, not so much the brand name itself.  For example, if I was going to buy soy milk, does it have to be "Silk"?  I wonder about that.

Not to mention all the debt that these guys have to deal with.  In any case, having looked at this for a while, I didn't come up with anything interesting enough to merit a whole post.  If things change, I may post something on it later.

Mr. Market
When I was looking at asset managers to come up with comps in a recent post (the OAK post), I came across GAMCO Investors (GBL).  Of course, we all know Mario Gabelli, a bubblevision regular and long time Barron's roundtable member.  GBL has been listed for a while too and has been talked about over the years.  I've always paid attention to what Gabelli has to say but never really looked that closely at GBL.  It still seems like an OK stock, nothing really exciting.

But what was interesting is that in the last few years, Gabelli has this excerpt from the Intelligent Investor at the beginning of his annual reports.

Imagine that in some private business you own a small share that cost you $1,000.  One of your partners, named Mr. Market, is very obliging indeed.  Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or sell you an additional interest on that basis.  Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them.  Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.

If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise?  Only in case you agree with him, or in case you want to trade with him.  You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low.  But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.
- Benjamin Graham, The Intelligent Investor

This is nothing new.  We all talk about Mr. Market all the time, but I do think that sometimes people forget about that.  For example, all the complaining about high-frequency traders, market distortions due to leveraged ETFs, hedge funds making markets more volatile, the frustration with the "risk on/ risk off" modes of the market (which reminds me of the "inflation day / deflation day" markets not too long ago) makes me wonder if we forgot that Mr. Market is irrational.  It doesn't matter what form it takes; in one era they were daytraders and SOES bandits, in another it was the index arbitrage and portfolio insuring delta hedgers using futures.  How about the days (before my time) when markets moved based on money supply figures published on Thursday nights?    Now the players are different, but still irrational.

We need these people as value investors.  We need people to be trading stocks based on things other than fundamental values.  Value investors love people who sell a stock because it breaks below support and think it will go lower and buy stock as it gets more expensive.

Without these people, who will we sell to and buy from?  The crazier and more insane Mr. Market is, the better it is for the value investor, as long as they are not leveraged and have their fate dependent on the generosity of a prime broker.

Interesting Conversation
I was at Barnes and Noble the other day (I am such a boring person that nothing to me is as exciting as browsing a bookstore.  Oh, getting a fresh-off-the-press annual report in the mailbox is actually a little more exciting) and was wandering around in the business/finance section.  This particular bookstore was near some major financial firms so had a larger than normal finance section.

Anyway, I overheard an interesting conversation.  I almost jumped in but thought better of it and quickly walked away.

The conversation was between some young, pimple-faced kid (maybe early to mid 20s) and a young middle-eastern looking kid of around the same age. 

I heard the young kid tell the middle-eastern kid that he runs a macro hedge fund  (this reminds me of another time when young kids seemed to jump into something!).  He said why bother with stocks?  If you buy a stock you like, like a consumer staple, the stock can go down because of what happens in Europe even if it has nothing to do with the company you own.  Why bother with stocks then?  It makes no sense to own something where the stock price is impacted by factors that have nothing to do with the business.  So therefore, he explained, he primarily buys and sells corporate bonds, government bonds and foreign currencies.

Well, OK.  I was tempted to jump in with my thoughts, but I know how these conversations tend to go so I just thought better of it.

This reminds me of the Lind Waldock TV commercials not too far back.  The commercial was similar to the above conversation.  Some lady was talking to some guy and she says, why bother with stocks?  With stocks you have problems like p/e ratios and corporate scandals. Why bother with that?  Just stick to what you know, like coffee and crude oil.

As much as I am a fan of free speech and free market capitalism, I thought that was awful; to try to convince people in TV commercials that speculating in commodity futures is safer than investing in stocks.

Anyway, this conversation reminded me of the above Mr. Market story. We should love that markets go up and down for the wrong reasons.

When to Sell
So someone asked me when it's a good time to sell after buying a stock.  That's a really good question.  In the investing world, sometimes it's harder to figure out when to sell rather than when to buy.

For someone like Buffett or other super-long term investors, this is not an issue as his favorite holding period is "forever".  In that case, when to sell is not an issue (even though he regrets not selling Coke in the late 90s).

There are many reasons to sell.  An investment can be a mistake, an error in analysis etc.  Things can change at the company for the worse and it can turn into something that is different than what you initially imagined.  But I would advocate never selling due to short term concerns about the economy or next quarter's earnings.

Otherwise, if you buy something thinking it's worth $100 at $60, you typically would want to sell it at $90 or $100.

But is it always that simple?  What if the company is growing at 10%/year and you think this is sustainable.  Wouldn't it be OK to hold it even at fair value if that fair value is growing at 10%/year?  I would say yes, assuming the intrinsic value calculation is conservative.

If what you own is an excellent company with great management with a great track record, I would be inclined to own it even at fair value or above.  How many people would have sold out of Berkshire Hathaway years ago after making money on it?  Maybe someone bought it at $50 in the 1970s and sold it at $100 or even a whopping $200 (now trading, as we know, at $130,000/share).  Surely some people bought at $50 and sold at $500 for the best trade in their investment lives.

A recent example is AAPL; I remember a good friend kicking himself for patting himself on the back with Apple.  I think he bought it at $10 and sold out at $20.  Homerun!  He was complaining about this trade when it was at around $70.

Apple is not a great example because I too didn't see this coming either; after every hit product I wondered what the next thing will be.  I was late into the game and did well on it, but I don't know that AAPL is a company that will sustain their edge for the next ten or twenty years.

So back to the question; if I bought a stock because I thought it was cheap, then I would sell it when it is no longer cheap unless it is one of those 'great' companies that I want to own over the very long term.

Comparing to alternatives is also a good idea.  If you buy a stock for 60% of intrinsic value and then sell it at 90% of intrinsic value, where do you put that money?  Is there another stock trading at 60% of intrinsic value?  Is intrinsic value growing at a pace that makes owning the stock close to intrinsic value attractive?

Sometimes owning a company that is growing intrinsic value at 10%/year at intrinsic value is better than owning a non-growing company at 60% of intrinsic value, unless there is reason to believe that the discount to intrinsic value will close relatively soon.   This really all depends.

Greenblatt's book (The Little Book That Beats the Market) has shown that stock prices do routinely get undervalued, and really cheap stocks tend to get back to higher values in a year, so focusing on what something is worth should still be the primary goal (again, except for when structuring permanent, long term portfolios).

This is interesting because in his other book, I think he said that some of his best investments took two or three years before it really took off (I think he was talking about spinoffs).

When to Buy
And this leads to the other question; when to buy?  People are so concerned about all sorts of things that they don't want to own stocks.  So if you don't buy a stock you like now because of worries about a European implosion, the fiscal cliff or the elections, then when do you buy?   If these uncertainties clear, wouldn't stock prices actually be higher?  Yes, if the nightmare(s) are realized, stock prices can also be materially lower.

So if you get out of stocks now to buy back in later when it feels better, then the math that has to be done is:  What are the odds that the negative scenarios unfold?  What are the odds that stock prices go down because of that?  And then what are the odds that you will have the courage to be able to buy stocks when it goes down?

I was going to pull out some old spreadsheets and actually calculate the economic value of owning cash right now in front of all of these uncertainties.  You can use exotic option pricing models to see what the value of holding cash now is and waiting for a market decline.  This can be compared to just owning stocks now and what the long term expected return is based on the current price  (down-and-in knock-in call options, lookback call option (where call buyer gets to choose lowest price in certain period etc...) pricing models can be used to calculate the theoretical value of this optionality).

But it's a hassle, so maybe I'll do it one of these days but not today.

The point is, if you can buy a stock now with an expected return of, say, 10%, that's great.  It's probably better to forget about what can happen between now and the medium to long term.  Who cares?

If you know that the business will grow 10% per year and the stock price will move up with that, who cares if there is a crash in October that would allow you to buy it 20% cheaper then.  In fact, if you plan on holding the stock for a long time, then the 20% discount isn't even that important;  if you plan to hold something for 10 years, a 20% discount will bump up your annualized return from 10% to 12.5%.  Over 20 years, a 20% discount will bump up your return from 10% to 11.2%.

Of course, 2.5% is not trivial.  Over time, that compounds meaningfully.  But the point here is that the other side of the equation is that the 20% discount may not come and the stock can run away. 

As I keep saying again and again, if you go back to the beginning of the year and gave someone just the headlines throughout the year 2012, nobody would guess the market would be where it is now...

This is not to say that we should all be 100% fully invested.  As Greenblatt said in a column at his website (that I can't find there anymore), one should own as much stocks as one can stand to watch it go down 50% because the stock market *will* go down 50% every now and then.   The mistake people made in 2008/2009 wasn't that they didn't get out in time.  It was that they owned too much for their own comfort so they sold out in fear at the lows to make their losses permanent.

Also, Buffett has said many times that he has never not invested in something because of his or someone else's outlook on the economy, macro risks or anything like that.

OK, anyway, this was another meandering post but at least I put something up. 

I hope to be more active going forward with some interesting things to look at.


  1. Interesting. Are you willing to share your work on DF? I was also looking into this. I can share my work with you. daneskola@gmail.com

    1. Hi, at this point everything is on scraps of paper here and there and I haven't even really inputted anything anywhere so I don't know if there is much to share. If you have something simple put together you can send it to me or we can discuss it over email. I will email you.

  2. very interesting conversation, i specially like the one you overheard at the book store..hah.

  3. I've been thinking about "When to Buy" lately - torn between buying more of some things that I like, and continuing to wait for an "air pocket". I've continued thumb-sucking because of Katsenelson's (among others) idea of sideways markets, which end with very low valuations. Do you have any thoughts on this theory?

    1. Hi, I haven't read K's book, but I have my doubts about an investment technique tailored for a certain market condition. If we know what the market condition is going to be, it would be easy to make money. One might have concluded in the late 1970s that the market is a side-trending one (just in time for it to change!). This is not to say that the market will take off soon now like in the 80s.

      But one should always be wary of different approaches for different market environments. The Superinvestors I always talk about and Buffett has done really well over the years and it's important to think about how they did that. Did they do one thing in bull markets and then something else in sideways markets and then something else in bear markets? Is that really how they made their money?

      Show me someone with a good, documented long term track record that applied the different approaches at the right times in the right kind of market environment. I bet you won't find anyone.

      This is not to say that you should just jump into the markets either. If you don't understand the business and whatnot, and would be worried that the market will be flat for the next ten years, then maybe one shouldn't be in stocks at all.

      Anyway, the reason why I advocate so much what I do is because there is extensively documented proof that value investing done well does work over time.

      When one tries too much to fit their strategy to current market conditions, there are all sorts of other risks that come into play (remember those hedge funds that promised 1%/month? Those are long gone).

      That's my take...


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