In other words, unless you believe there is no such thing as a stock trading at a 75% discount to intrinsic value, you cannot logically conclude an analysis is wrong simply because the stock drops 50% after you’ve identified it as a bargain.
So if a 50% drop isn’t a mistake, what is?
According to the American Heritage® Dictionary of the English Language, a mistake is:
An error or blunder in action, opinion or judgment.
Thefreedictionary.com is somewhat more helpful. They point out some causes:
An error or fault resulting from defective judgment, deficient knowledge, or carelessness.
What was my thesis for Gigaset AG?
As of March, Gigaset had €40 million of cash and no debt worth mentioning. In 2011, the company earned roughly €20 million before tax.
From an owner's perspective, that’s a 50% yield after adjusting for excess cash.
Twelve months later, the company is sitting on €30 million of cash. The bad news is that they took on €30 million of debt to maintain that cash balance. Gigaset AG did not generate €20 million of owner earnings. They burnt through €40 million instead.
That is not sustainable. Gigaset AG is in dire straits.
Was this knowable?
I don’t know. I don’t think so but it's crystal clear that I was willing to bet serious money against this result. I misjudged the risk. What’s worse, the information was there. I was careless.
Like before, Gigaset dominates the European market. Not only did they gain market share in 2012, they did it with even higher gross margin (now 50%). Basically, they sold more phones at higher prices than the competition. In short, the business performed precisely as I expected…. and lost a lot of money. Ouch.
The problem is that selling phones is tied to the housing market. The European housing market in 2012 was not unlike the U.S. housing market in 2010. Frozen. I’ve watched this movie before. I’ve been tracking Natuzzi for years. Natuzzi has superior gross margin, good brand recognition and not enough revenue to cover costs. This has led to a long string of losses.
Gigaset went down with the European housing market exactly like Natuzzi tanked with the US's housing market. As was pointed out by forum members, Gigaset is a long way away from gaining the market recognition abroad that it has in Europe. The growth in the U.S. and Asia hasn’t come close to offsetting the decline at home.
To add insult to injury, the man at the helm, Peter Löw, has left the bridge.
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When analyzing a company with superior gross margin, check how this trickles down to the bottom line (efficiency). With superior gross margin a company should also have superior net margin. If not, the company may be “bloated.”
In any case, the higher cost structure must be accounted for. Are the costs fixed (pensions) or variable (advertising)? Is the company investing heavily for growth?
Had I taken the time to analyse the efficiency of Gigaset AG, I would have seen that the gross margin of 50% was not making its way to the bottom. My estimate of earnings (pre-tax) was € 20 million. This means net margin was coming in at less than 4%. Vtech's net margin is almost three times as high on much lower gross margin. As it turns out, faced with some headwinds, Gigaset is struggling to cut costs. For now, they are failing. In a year, they've burnt more cash than their market cap. That's certainly not the case at Vtech.
The numbers were in front of me. I ignored them. An unforced error.
Peter Löw resigns.