As disciplined, contrarian investors, our take on a stock is often at odds with Wall Street's consensus. Portfolio Manager and Principal Jay Kaplan explains why we carefully assess the value of our holdings and why discipline and conviction are paramount to both buy and sell decisions.
At Royce we talk a lot about the key criteria we use to buy stocks, but we rarely delve into the details of what drives us to sell. Yet selling is arguably as important as purchasing shares. Trimming or exiting a position requires a similar degree of discipline and conviction, both of which are paramount to our approach. While it is often easy to buy a stock, it's never easy to sell.
With every company that passes our screening and analysis processes, we establish a buy and sell target. Most commonly, these target prices are based on our estimate of the company's intrinsic worth, which we calculate using our business buyer's approach.
Our targets are dynamic, frequently moving around as conditions change. We keep a constant vigil on both our position in a company and its weighting in each portfolio as stock prices—and our targets—move up and down.
Any number of developments can influence our decision to sell
- The company might not be executing the way we think it should
- Management may do things that pile too much leverage onto the balance sheet or erode a once-formidable market share
- Earnings might flatline or decline to what we think are alarming levels
- The stock price might move well beyond our established sell target
Our recent experience with WWE offers an effective illustration of the factors that lead us to sell.
Our Introduction to WWE
Based in Stamford, CT, WWE is a family-operated sports entertainment and integrated media business that went public in October 1999. Its programming is broadcast in more than 150 countries and 30 languages, reaching more than 650 million homes. The company's core businesses are live and televised entertainment, consumer products, digital media, and WWE studios.
Before we bought shares, WWE had sought to aggressively build its brand. Notwithstanding the occasional misfire (such as its foray into professional football, the XFL), the company enjoyed pretty consistent success.
We began to build a position in the summer of 2004 based on our high regard for its great brand, strong balance sheet, reasonable cash flow, and a solid dividend with an attractive yield.
Sluggish Revenues and Other Challenges
The recession and 2008 financial crisis saw the business hit a rough patch—WWE's primarily low-to-middle-income audience felt the full effects of the economic downturn, the company made some questionable moves, and increased competition from UFC (Ultimate Fighting Championship) and MMA (mixed martial arts) was robust.
All of this led to relatively uninspiring financial results in the form of sluggish revenues from ticket sales, cable broadcast fees, and pay-per-view events over the last several years.
In an effort to boost ratings and attract more mainstream advertising, the company in 2008 began to clean up much of its programming to appeal to a wider, more familial demographic. Believing in the business's potential to tap into a wider audience—and liking its attractively low share prices—we spent much of 2008-2010 substantially increasing our position.
Signs of a Turnaround?
We continued to hold a large position entering 2013. That summer, the company prepared to announce two potential catalysts to boost revenues. The first of these was the launch of the WWE Network, which the company first discussed in late 2011 after seeing the success enjoyed by the NFL, NBA, and Major League Baseball networks.
Ultimately, the company decided to deliver the network using over-the-top distribution —meaning it would be available over internet video channels such as Netflix and Hulu.
WWE also wanted to take better advantage of its lucrative broadcast rights fees for live events. The company had structured its major cable TV contracts to expire at the same time, betting that it could better its deals with NBCUniversal based on the rates that other sports organizations were receiving. NASCAR, for example, landed a multibillion dollar, 10-year deal with NBC and Fox in summer 2013.
WWE reasoned that, because it boasted higher ratings, it could potentially double its cable revenues when its contracts came up for renewal. WWE's two major cable network TV shows are “Raw” on USA and “Smackdown” on Syfy (both channels are subsidiaries of Comcast Corp.'s NBCUniversal), which regularly rate among the most watched television programs on cable, reaching a domestic audience of almost 15 million viewers each week.
The Decision to Sell—A Contrarian Move
Along with other investors, we met with management in the summer of 2013 to discuss these initiatives. The market seemed to share the company's excitement about its very optimistic projections as these two events—the renegotiated cable deals and online launch of the WWE Network—led its stock price gradually up in late summer of 2013. The pace began to quicken as the year drew to a close.
2014 saw us reevaluating the stock in light of this rapid rise. Having done our analysis and taken a close look at the numbers, we concluded that while WWE's plans were promising and likely to produce improved revenues, it seemed unlikely to perform at the level that the company and an increasing number of investors were anticipating.
We believed that its share price reflected a highly optimistic, best-case scenario for the stock. As perfection is, at best, elusive, we made the decision to begin selling.
As we began to reduce our position, the stock, in the span of the first four months of 2014, marched from the mid-teens to the low thirties based on high expectations for new TV contracts and the online network launch. By the time the stock reached $30, we had already reduced our shares significantly.
When WWE finally signed a new cable broadcast deal with NBCUniversal in May, the latter announced that they had settled on agreeable terms—a 50% increase from its last contract. This was a significant bump, but well below the double-the-previous-rate that WWE had originally projected.
In addition, the company faced larger-than-projected near-term losses from the launch of the online network. By the following day, WWE's stock had fallen nearly 45%.
It's important to point out that luck played a sizable role in our experience with the stock. One of the criticisms of value investing is that it can result in buying a stock too early and selling too early.
Certainly there were many investors who were convinced that WWE was a good buy through mid-May of this year.
This is a common dilemma for any contrarian investor—we need to have faith in the validity of our analysis of any given company because more often than not we are buying when most others are selling and selling when they are buying.
The point, then, is not that we know better—we have been wrong many, many times about a number of companies. Yet to enjoy any success picking stocks, you need to trust your own judgment, validate your conclusions (to the degree that you can) with math and strict analysis, and act on what you know, regardless of what others may be doing.
Important Disclosure Information
Jay Kaplan is a Portfolio Manager and Principal of Royce & Associates, LLC, investment adviser to The Royce Funds. He is the portfolio manager of Royce Total Return Fund (RTR), Royce Value Fund (RVV), Royce Dividend Value Fund (RDV), and Royce Capital Fund – Small-Cap Portfolio (RCS). He also assists on Royce Pennsylvania Mutual Fund (PMF). The thoughts and opinions expressed in this piece are solely those of the person speaking and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.
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