At or about this time each year, I engage in an endeavor I call my annual autopsy. This exercise entails an analysis of each and every sell decision made the previous year with an eye towards answering three questions:
- What was I trying to accomplish when I originally bought the sold security (i.e. what was the thesis and my profit dynamics)?
- What actually transpired?
- What did I learn?
Every year is largely unique and often correlates to where we are in the bull/bear cycle. In bull years, common lessons have been: 1) I should have bought more and 2) I sold too soon. In bear years, my scolds have tended towards: 1) Quality really matters when times get tough (a la Mr. Buffett’s proverbial naked swimmers when the tide goes out) and 2) going into the eye of the storm, even with the good guys in an industry, makes for a very hairy ride (e.g. mortgage insurers in 2007).
My 2011 review produced the thought encapsulated by the title of this piece. In both 2010 and 2011, I enjoyed good success buying mediocre but very cheap businesses: leveraged casino companies and for-profit education companies, to specify two examples. The key to the successes here was neither a brilliant evaluation and deep understanding of the business models nor a nuanced, keen insight into a regulatory environment’s tit-for-tat. No, it was much simpler. The key was maintaining a cogent base case valuation level that I firmly believed in, and then, most importantly, acting on this belief – through both buying and selling – as the manic Mr. Market over-reacted to the news cycle. In other words, the key was doing the basic homework on the securities and then practicing the necessary patience and discipline to buy the adequately discounted price and sell the close-to-fair-value price.
While I have never considered myself a trader, during these volatile years (especially 2011), my clients have been rewarded when we traded around these mediocre-in-the-long-run, volatile-in-the-short-run positions. The good news about being a fundamentalist, moreover, is that given my firm belief in the fundamentally-derived valuations of our studies, we would have remained content had our adequately discounted prices not budged and might have even bought more had they moved lower. The time-to-the-realization-of-value (i.e. focusing on catalysts) is a game I refuse to play for the most part. When values are realized quickly, I consider it to be fortuitous, and the only charge in these instances is to make sure that the values are, in fact, realized via selling.
There is another kind of company, however, that contradicts the above notion to sell when the price reaches its full valuation level. In the title, I have called this the business model company, and I confess that I have regretfully been very poor to recognize and prosper in this arena. One company that I have followed over the years – kept on the screen, if you will – that belongs in this advantaged business group is Ross Stores. I recently revisited the company – courtesy of a reminder from Akre Capital in the December edition of the Value Investor Insight – and was astounded, yet somewhat unsurprised, by what a flat-out smashing success Ross has been in the past decade. I say unsurprised because the thesis ten years ago was, in fact, clear, understandable, believable, and compelling.
Ross and TJ Maxx buy desired, good quality merchandise from forced or, at the least, eager sellers and then distribute with scale advantages to desirous customers for cost-advantaged prices. A decade ago, Ross and TJ Maxx were poised to win with this model, and win they have. As an investor, there were, along the way, a handful of entry opportunities that weren’t too painful from a valuation standpoint. Had one taken the plunge, however, the key would not have been simply closing the gap of a couple of multiple points but rather to have hanged on as these two wonderful businesses compounded their earnings power. Alas, I can say that I was not along for this ride but look forward to a future annual autopsy when I can say something akin to: after a decade of earnings compounding due to its superior business model, I finally sold XYZ stock for 25 times the original investment and walked off into the sunset. The great business model companies are the ones that can produce such life-changing returns if you can find them and stick with them.
Eric Houssels is the co-founder and managing member of Houssels Capital Management LLC, a money management firm based in Las Vegas, NV. The firm focuses on investments in the stocks of publicly traded companies of all capitalizations that possess, preferably, significant earnings power or, alternatively, assets that can be (re)deployed to achieve significant earnings power and are trading at reasonable valuations. Houssels Capital Management was founded in 2000.