Berkshire Ruminations

Wednesday, January 16, 2008

The Agony of Defeat

This is one of those times when I just don’t know what to say. Perhaps it’s my relative inexperience, perhaps its just human nature. But the market is tanking, I am losing money and I can’t help but second guess my past decisions. It is important not to make emotional decisions, but to tell you the truth it is hard to tell if the decisions I am making even are emotional. By that I mean, it’s tough to know whether I am rationally changing my own perceptions, or whether I am allowing the pundits that pervade the news sources from which I get my information to sway my opinion.

I know not to let fear or greed influence my decisions, but how do I know if they are? I know to let the market be a tool, not a guide, but it is hard to rely solely on my own interpretation of available information. After all, how arrogant must I be to assume I am right while everyone else in the market is wrong? Bottom line: this is the type of environment when investing is most aggravating.

Of course the biggest losses have come from the financials. Those are the easiest to brush off too, since it was much more of a macroeconomic phenomenon than a company-specific one effecting these losses. It is the individual picks that cause the most distress.

For me, the one individual stock for which this frustration is most pronounced is Sears Holdings. I’m not really sure what to think about this investment anymore and at times I struggle with the question of whether my original purchase of the stock was an emotional one, or one based on a rational consideration of the facts. The question is justified. Ever since Business Week asked in November 2004 if Eddie Lampert was “the next Warren Buffett,” folks started jumping on the SHLD bandwagon. Maybe that was reason enough for me to stay away. But I didn’t. I jumped right alongside them. Now, it seems, they are all jumping off that bandwagon. Why? Let’s talk about that.

A year ago, the theory was that Lampert would use Sears as a vehicle by which to invest in other businesses (a la Warren Buffett and Berkshire). Folks debated this issue, but the theory that Lampert saw the company as merely a turnaround lost out to the competing theory from the bulls who had more faith in Lampert’s investment prowess. As such, the story went, whether or not the retail business really grew (Lampert claimed he wanted it to nonetheless) was not of top concern, since the plan was to merely use the cash flow from Sears’ current operations to make better investments outside the company.

But now, it seems, the retail business is so bad that it isn’t even generating that cash flow! So Lampert is left with no cash to invest, at precisely the time when the market might be creating the best bargains. Remember, this is a company directly competing with Wal-Mart, not an enviable position in which to be for anyone.

In addition, everyone thought Sears’ real estate assets were a hedge against the performance of the company’s retail operations. Ha. What does the market for commercial real estate look like these days?

The plan appeared to be working because Lampert did, to his credit, do a great job cutting costs and boosting profitability. So even as sales lagged income rose. But the benefit of cost cutting is limited by the company’s sales. Don’t get me wrong, Eddie Lampert is certainly one of the most successful hedge fund managers in recent years and obviously a very bright and astute businessman. I love the way his shareholders’ letters are written and the obvious parallels we can draw between them and Berkshire’s. But that doesn’t change the fact that he must begin by making sure the utterly lousy retail business he is burdened with doesn’t completely fail.

Part of me feels foolish for even writing about this. It has been written about to death. And 99% of that writing is motivated purely by the hope that Business Week was right. Nobody knows at this point if the company will survive long enough to turn in to a new Berkshire. But we hope it will.

Note the word “hope.” This is an emotion. And if I bought SHLD “hoping” that it would become something huge then I was greedy, because there was not a whole lot of evidence indicating it would be. There reasonable speculation, but no solid evidence that would afford the margin of safety that I should have demanded. There was a lot that could have gone wrong that I should have considered, but I didn’t because I let the dollar signs blind me. Ah, hindsight.

I think the lesson from all of this is the following; Emotional discipline is the number one most important factor affecting investment performance. Warren Buffett has been successful because he has that emotional discipline. I think he would have passed on Sears Holdings, even as great a guy as Eddie Lampert is. But just as it is so difficult to change one’s personality, if we don’t already have emotional discipline we can’t expect to obtain it easily. And this might just make some type of structured investment philosophy that disallows the influence of emotion preferable.

8 Comments:

  • Hi,

    I feel if you buy high dividend yield stocks with additional research..Then you are paid to wait ..(as long as Yield is higher than the good bond)

    Though Berkshire is not paying dividend , its subsidaries are paying liberal dividend to Warren.

    Vishnu

    By Blogger VISHNU, at 16 January, 2008 07:44  

  • Keep your courage, i lost much more than u in C. Remember what taught bought in margin, lesson learned.

    By Blogger Philip, at 16 January, 2008 08:08  

  • Andy,

    Here's an interesting article on SHLD .
    http://www.portfolio.com/news-markets/national-news/portfolio/2008/01/14/Kmart-Sears-Merger

    Remember that it was many years before Buffett sold off the textile business that provided Berkshire with cash to invest elsewhere. The same can be true with SHLD.

    By Blogger Will, at 16 January, 2008 08:11  

  • Hi Andy,

    One things for sure, you are in good company. Bruce Berkowitz and Bill Ackman must be pretty worried too as they have lots of SHLD. Berkowitz has made very few big mistakes , if any, since he started the Fairholme Fund. Let's hope SHLD is not his first. Best wishes.

    By Blogger #2, at 16 January, 2008 11:33  

  • In one of his quarterly letters, last year in 2007, Lampert wrote that value un-locked in Sears was that in the sub-par operating metrics.

    If Sears could rise to industry benchmarks, then value would be realized within the retail operations. This focus scared me, since I was investing and waiting for the big financial maneuver; whether it be real estate liquidation, or selling or partnering the strong brands.

    After the stock fell in late 2007 from $190 to $130, I revisited the situation and felt that so many negatives were swirling around Lampert and his key holdings that new investors like Ackman signaled that he was going to make a financial maneuver.

    Now the stock has been thoroughly distributed and financial options seem less likely, because they all seem less valuable as the consumer is staring in the face of recession and a severe contraction of debt load.

    Lampert is known to be Buffett-like in his patience; and that may be tested. He has spent a lot of bullets on stock repurchase programs, his ESL fund may face substantial withdrawals, and current Sears shareholders are voting with their feet and leaving.

    I perceived a margin of safety in the stock as it fell to $130 and I'm now constantly assessing whether sub-100 prices are valuable.

    To see another very similar situation with a value investor who hit 2 early home runs in casual dining (Sadar Biglari), read about it in my last blog entry.

    Good Luck,

    Mike David
    www.marketrhymes.blogspot.com

    By Blogger Michael David, at 16 January, 2008 19:59  

  • Graham, etc. describe the difference between investing and speculating, but your thesis for investing in Sears puts you into a completely different catagory. You are basically placing your money into the hands of a well-known, very successful investor with the idea of using income from Sears to generate market beating returns. There is nothing wrong with that. You need to realize this is not value investing. It's somewhat similar to investing in a hedge fund or maybe a mutual fund and the fees are lower... When you invest with LUK, Y or BAM, you are betting on the management. With Sears, you are limited to the Sears and K-Mart asset base and free cash flow plus what managemant can do with it. Lampert said to look at the company as a start-up. It's probably a better asset base than the old textile mills of B-H. It makes money.

    You can't look at your investment in Sears in the same way Buffett buys stocks with a margin of safety because there are too many variables. You wrote that you invested in Sears because of Lampert. I am sure that the people who invest through ESL are feeling a similar amount of pain that you are if they follow the news as carefully as you do. If your original plan was to invest in Edward Lampert, then you should consider "locking" yourself in for five years and trusting that he will do what is best for his shareholders. No one can argue that he is not aligned with Sears shareholders. ESL owns almost half of the shares. He was buying back shares over $150 and has continued to do so at lower prices as disclosed. He is committed to the people of Sears as noted in his past two communications. You are a partner with Eddie.

    It seems like Mr. Market is roughing you up some. If you need some consolation, look at Fairholme, Bill Miller, Martin Whitman, Davis NY Venture, Pershing Square and the other holders of Sears. You have good company.

    By Blogger Porterhouse, at 17 January, 2008 16:35  

  • Graham, etc. describe the difference between investing and speculating, but your thesis for investing in Sears puts you into a completely different catagory. You are basically placing your money into the hands of a well-known, very successful investor with the idea of using income from Sears to generate market beating returns. There is nothing wrong with that. You need to realize this is not value investing. It's somewhat similar to investing in a hedge fund or maybe a mutual fund and the fees are lower... When you invest with LUK, Y or BAM, you are betting on the management. With Sears, you are limited to the Sears and K-Mart asset base and free cash flow plus what managemant can do with it. Lampert said to look at the company as a start-up. It's probably a better asset base than the old textile mills of B-H. It makes money.

    You can't look at your investment in Sears in the same way Buffett buys stocks with a margin of safety because there are too many variables. You wrote that you invested in Sears because of Lampert. I am sure that the people who invest through ESL are feeling a similar amount of pain that you are if they follow the news as carefully as you do. If your original plan was to invest in Edward Lampert, then you should consider "locking" yourself in for five years and trusting that he will do what is best for his shareholders. No one can argue that he is not aligned with Sears shareholders. ESL owns almost half of the shares. He was buying back shares over $150 and has continued to do so at lower prices as disclosed. He is committed to the people of Sears as noted in his past two communications. You are a partner with Eddie.

    It seems like Mr. Market is roughing you up some. If you need some consolation, look at Fairholme, Bill Miller, Martin Whitman, Davis NY Venture, Pershing Square and the other holders of Sears. You have good company.

    By Blogger Porterhouse, at 17 January, 2008 16:45  

  • I invested in SHLD in early to mid 2007 and get out for a small loss. The reason I bought SHLD is like you, having read a lot about SHLD and I'm "convinced". Yet I keep asking myself, is it "me" that want that stock? I finally dumped the stock for two reasons:
    1. I don't see a bright foreseeable future for Sears. It's just plain and old and not moving anywhere. No matter how hard Lampard tried to cut cost.
    2. I heard about Lampard using some creative financial technique to monetize some famous Sears brand. I find it just technique-playing rather than building business, another word, no value is created during the process.

    I then know it's a mistake for me to invest in SHLD. I put almost all of my money in AAPL since that's the one I know and understand. A major lesson for me and that's also one of Buffet's principal: invest in what you know.

    my blogspot http://kopusinvestmentnotes.blogspot.com/

    By Blogger An Investor's Diary, at 18 January, 2008 18:31  

Post a Comment

<< Home