In early 2009, I purchased a stock that I had been following for some time: Callaway Golf (ELY). At the time, the stock was trading for around $8/share, and was off a peak of nearly $20/share in mid-2007. In addition, the company had a book value of nearly $9/share, and had been profitable in ever year besides one from 2001-2008. While the company was on its way to a net loss in 2009, I felt that this was a temporary setback and that the company would soon be profitable and back to a mid-teens share price (consider the fact that in 2005 the company had received an all-cash $16.25/share offer from Bain Capital and MacGregor Golf). Fast forward two years and the stock is trading for $5.59/share, down more than 30% from where it stood in late 2009; here are the lessons that I took away from the failed investment (I exited with a miniscule loss in early 2011):
WATCH THE CASH – As Whitney Tilson noted in a recent interview on CNBC, Microsoft (MSFT) should issue debt to buy back stock and pay dividends because they have a consistent free cash flow generating machine and have no need for $50 billion plus in net cash on the balance sheet; for Callaway Golf, this isn’t the case. A great example of this is in 2008, when the company brought in a solid $66 million in net income; however, they also spent $51 million on capital expenditures, $10 million on acquisitions, $23.6 million on share repurchases, and $17.8 million on dividends. For a company like Callaway, which has proven highly cyclical, capital preservation should be paramount and the mix of reinvestment and distributions of cash to shareholders must be intelligently planned, a strategy they did not follow in the boom years leading up to the crash.
WATCH THE DIVIDENDS – In June 2009, Callaway was forced to issue $140 million of 7.50% Series B cumulative perpetual convertible preferred stock to remain in compliance with financial covenants. Sounds like a good time to cut the dividend, right? Well management eventually did… to a quarterly payout of $0.01. Why they felt the need to maintain the payout at a time when they were bleeding cash is beyond me; all I can tell you is that it was not in shareholders’ (meaning the long-term owners of the business) best interests; management’s insistence on maintaining the dividend at a time of turmoil showed a clear focus on stabilizing the short term stock-price and should have been a red flag to any prudent investor.
STAY AWAY FROM CRUMMY BUSINESSES (“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”)– At the end of the day, the most important lesson is that I have no merit in blaming the jockey; I should have realized the horse was a loser and never bought a ticket. The company has no sustainable competitive advantage, and was competing against a fierce competitor in Titelist (which at the time was owned by a division of Fortune Brands). It was highly dependent upon a country where participation in golf had consistently declined over the previous five years, and showed no real signs of slowing (an issue further exacerbated by the economic crisis). Despite knowing all of this well before buying any shares, I set it aside by telling myself that international growth would revive the industry (hasn’t happened) and that Callaway would catch up to Titelist and eventually lead the industry (hasn’t happened).
In the end, I walked away with nothing to show for my efforts while the DJIA & the S&P 500 both increased by 50% plus; over time, the lessons learned will hopefully pay for themselves many times over and prove to be a blessing in disguise.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of my portfolio (currently two). In the eyes of a businessman, I believe this is adequate diversification.