Berkshire Ruminations

Wednesday, December 27, 2006

Sears Holdings - Part 2

As soon as Eddie Lampert and his fund, ESL Investments, put together the surprise takeover of Sears Roebuck to create Sears Holdings, changes in the temperament of the company began to surface. Lampert, in his role as Chairman of the new company, immediately began insisting on undertaking only value-creating projects. Quit selling products at a loss just to compete with Wal-Mart. Quit carrying excess inventory. Quite simply, get more efficient. The most interesting change, though, is much more subtle. Within months, Lampert had decided to abandoned the ingrained Wall Street convention of hosting quarterly conference calls, writing quarterly letters to shareholders and providing earnings guidance in anticipation of the conference calls and earnings announcements.

Humorously, once Lampert ceased issuing earnings guidance, analysts quit following the stock! As if the analysts agreed in unison, “Well if the company won’t tell me how to rate the stock, then I wont bother trying.” We can infer what we wish about what this says of the stock analyst’s role in the market, but to put things in context, SHLD currently has seven analysts following the stock. Companies of similar size such as Best Buy, Starbucks and Charles Schwab generally have fifteen to twenty ratings.

Lampert’s dismissal of this standard Wall Street practice can be interpreted in one of several ways. On one hand, it may indicate his arrogance or contempt for the individual investor. This is plausible, as Lampert’s hedge fund owns 40% of the company – the individual makes up a comparatively small chunk of the ownership picture. On the other hand, perhaps Lampert and management simply want to avoid the burden of constantly having to answer to the market about matters of which it is not concerned. This is one explanation given by the company for its decision.

On yet another hand, perhaps it is indicative of his focus on the long-term prospects of the company. A couple of years ago, I was fortunate to meet and hear Professor Michael Jensen speak to our college. The famed Harvard scholar has, more or less, written the book on the incentives of corporate managers and appropriate ways to compensate them. On this particular day, his message was remarkably simple and clear: “We must stop the earnings guidance ‘game.’” His contention, later formalized in a paper called “Just Say No to Wall Street,” was that focus on the short-term expectations is responsible for many of the corporate governance issues in our recent history, particularly when executive compensation is directly tied to these short-term expectations. Further, he claims that an “overvalued stock can be as damaging to the long-run health of a company as an undervalued stock.”

This struck a chord with me as an admirer of Berkshire Hathaway, which provides no earnings guidance, and of Warren Buffett, who has insisted for years that he would rather Berkshire stock trade at a fair value than a high value. Since the overwhelming majority of companies today provide earnings guidance to analysts and host quarterly conference calls, we can not expect to invest only in companies that do not. However, when we observe a company abstaining from these practices, such as Sears Holdings, I feel we can be somewhat more confident that the managers are indeed managing in the long-term investor’s best interests.

One more reason why SHLD may be an interesting ride.

FD: I own shares of SHLD


Post a Comment

<< Home