Most of my articles as of late have revolved around Staples (SPLS), and I think my activity to date presents an interesting case study that may be insightful for others (it’s always best to learn the bad lessons vicariously).
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.
About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with 2-5 positions accounting for the majority of my equity portfolio. From the perspective of a businessman, I believe this is sufficient diversification.