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As I laid out in my August 10 article outlining my contest submission, I believe the company’s intrinsic value is north of $20 per share; at the time of writing, I had already taken a small position in the company, with a cost basis around $14 per share. Since that time, the stock has been pummeled, falling roughly 20% in less than three weeks.
Generally, my strategy is to average down on securities as they become more attractive, particularly if they possess an insurmountable competitive advantage that leads me to believe that any current fundamental (or price) weakness is temporary in nature. With Staples, this is less certain – I’m much more confident about PepsiCo’s (PEP) growth prospects in China over the next decade than I am with the shakeout of office supply retail chains in the U.S.
Of course, none of this is new – I had felt that way from the start, and as such demanded a significant margin of safety (and potential upside) in the case of Staples, where I knew the potential for risk (permanent impairment of capital) was more pronounced.
The recent price action has put me in a tough situation; while the Q2 results were weak, I still feel that the company’s delivery business will continue taking market share, and that the company will be the ultimate beneficiary of retail consolidation. The problem is that I’ve never been as confident in these assertions as would be necessary for me to make it a top holding in my portfolio (on the other hand, I would buy PepsiCo hand over fist in a similar scenario).
The issue comes down to position sizing, particularly as it relates to the remainder of one’s portfolio. When I initially took a stake in SPLS, I was cognizant of the fact that I would want to add on dips, but positioned it too aggressively and left myself with little room to maneuver in the case of a sustained decline while still remaining comfortable with the positions size – and as a result, I have not been able to capitalized on the situation as I would have liked to.
What can be learned from this? I think a couple of conclusions can be drawn:
1) Simply avoid companies that you are not happy to purchase (in a big way) on short-term problems - if you are not happy buying a company when its stock falls 25-30% on pure volatility, then you shouldn’t enter the position in the first place; if you are getting to a point where you’re too committed to a particularly gut-wrenching position, stretch out your purchases when averaging down (my biggest mistake) to leave adequate capital while still staying in your comfort zone (it’s better to miss the bottom tick than to be left with no dry powder while your mouth’s watering).
2) Size your positions accordingly – particularly when initiating them. When you see a tantalizing opportunity, it’s easy to become overwhelmed and act overly aggressive (neurologists have found that the anticipation of financial gain is similar to the brain activity of a cocaine addict); make sure to leave yourself the room to capitalize on further irrationality if the opportunity presents itself.
3) Stay focused on what matters – and give investments the necessary time to play out. The important thing is to continue basing decisions upon sound (unbiased) fundamental analysis (an investment journal is a great way to compare your current thoughts with the original thesis).
While I’m not too happy with the way I’ve sized my stake in SPLS, I stick by the analysis presented in early August; time will tell whether or not that thesis was accurate.
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In my Q1 letter, I mentioned often you are disappointed in investing as either you buy too much too soon or on the opposite end you buy too little and the stock runs up. On the selling end, again either you sell too soon or too late....
So, I think buying and selling should be in multiple transactions (say 2-3). You can never pick the bottom or sell at the top. Whether you buy in equal proportions or not is an individual choice.
I have been in a similar position as the author when i went in with a full position. Price drops 20% or more and then you have less room to add. So, now I decided to buy 50-60% of the intended position initially (with exceptions) and then wait for either further drop in price (10% or more) or a period of ownership. The latter may give more confidence about the thesis playing out and you can add to the position even at slightly higher prices ( as long as margin of safety is sufficient). If the stock runs up and you cannot add, you can feel happy that you were right and bought a decent sized position. If the stock drops, then its perfect and you can add with more knowledge about the business.
On 3) giving time is important. Patience is key. From my experience, it does seem that 2 years is plenty of time for most ideas to work out, possibly 3...unless its deep deep value and the entire industry is in a slump and you have bought too soon. However, it is essential to follow the company results and make sure that the thesis is not flawed and the situation becoming worse. This is easier said than done. Often its too cloudy to make this judgement. When the stock drops 20% and the results are poor, it is not easy to always judge if this is a short term problem that is dragging on longer than you expected, or its time to bail on the investment. Averaging down is not an easy and natural choice. Averaging down constantly can be path to serious trouble. (Averaging down on value traps can get your head handed to you. anyone average down RIMM/NOK or the chinese frauds?)
Coming back to the authors point of sizing, if you have regular savings then you can always contribute to that position as your capital base is constantly growing and the size of each position is shrinking on a relative basis
thanks
Adib