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The Science of Hitting
The Science of Hitting
Articles (449) 

Short-Term Noise and Long-Term Investing

An example of why long-term investing is harder than it sounds

August 01, 2017 | About:

Under Armour Inc. (NYSE:UA) (NYSE:UAA) reported ugly results on Tuesday. Most notably, management cut 2017 guidance across the board, giving analysts another reason to doubt the company (there are few things the street hates more than a company that cannot predict results six to twelve months out with pinpoint accuracy). Sales growth has slowed and margins are under pressure. UA is experiencing some pressure. As an investor, this is a frustrating period.

But periods of frustration are part of life as a business owner; there are bound to be times when things are not going your way in the short term (at the macro level, industry level or company level). Anybody that bought Under Armour shares with the expectation there would never be bumps in the road is learning a painful lesson – and probably deserves the lumps they have taken.

Periods of business volatility (and the lower stock prices that usually follow) are difficult for many people because they do not have a strong sense for why they own a stock in the first place. They buy a few shares on a tip from a friend or because an analyst on CNBC comes out with a buy recommendation on strong channel checks heading into earnings. When you do not personally understand the rationale for owning a stock , significant price declines can be very difficult to stomach.

This is exacerbated by a financial press and analyst community that are overwhelmingly focused on short-term developments. Current results are overanalyzed and extrapolated in perpetuity. In the eyes of the press, you are either changing the world as we know it or on the path to extinction.

The combination of these factors is why I think long-term investing is so difficult for most people. Maintaining perspective can be difficult even when you have done your homework. Considering the vast majority of investors never get that far, I can only imagine how painful these situations can become. In that case, bailing at the first sign of trouble seems like a reasonable answer.

But even if that is the right decision over a two or three year window, it may prove costly over the long term. Consider Nike’s (NYSE:NKE) experience in the late 1990s. After years of breakneck growth, Nike stumbled. Sales declined from $9.6 billion in 1998 to $9 billion in 2000. The decline in sales outpaced cost cuts, resulting in a few hundred basis points of net margin compression. As a result, net income fell from $796 million in 1997 to $597 million in 2000 (down 27%).

Here’s some commentary from an early 1998 New York Times article titled “Nike’s Problems Don’t Seem To Be Short-Term To Investors” (bold added for emphasis):

“The leading maker of sneakers in the world, Nike warned on Tuesday that its earnings would be disappointing for the current quarter and said a corporate restructuring was to come. Stock analysts raced to lower their Nike profit forecasts for up to two years. Josie Esquivel, who follows the company for Morgan Stanley, Dean Witter and at one time expected annual earnings growth of 30%, is now forecasting 'zero growth over a three-year period.'

The drastic revision suggests far more than a short-term inventory problem. As Asia's economies falter, bloated inventories have indeed stunted growth in what Nike has long described as one of its most burgeoning markets. But far worse, retailers there have begun canceling orders.

The company has similar problems in its core market in the United States. Sneakers are falling out of fashion in some circles. ''Brown shoes,'' like Wolverine's Hush Puppies and Caterpillar brands, are being rediscovered by young adults. In addition, a number of new stores specializing in athletic footwear have opened in the last year, saturating the market and leading to huge price cuts on some of the company's most popular styles.”

When that article was written, the stock had already declined nearly 40% in the prior 12 months. Over the next two years (from February 1998 to February 2000), the stock fell another 35%. That is a three-year window where Nike shares fell a full 60%. By comparison, the S&P 500 was up about 70% over the same period. Needless to say, this was a difficult couple of years for Nike investors.

Undoubtedly, many threw in the towel in 1999 or 2000 in search of greener pastures elsewhere. They were getting a clear signal Nike’s best days were clearly behind it; the company could not grow revenues anymore, margins were compressing and the stock price was plummeting.

With the benefit of hindsight, we can see Nike ultimately managed to find a way forward. From 2000 to 2016, sales more than tripled. Net margins expanded a few hundred basis points and the share count was reduced by roughly 20%. Finally, Mr. Market became a believer again, giving the company a much higher price-earnings (P/E) multiple than he was willing to 16 years earlier.

Those that managed to hang on have been handsomely rewarded: according to Google Finance, the S&P 500 has increased 75% to 80% since February 2000. Nike shares, on the other hand, have climbed more than 1,000% over the same period (there was a lot of movement in the stock back then, including a two-day decline of more than 25% in early February 2000; if your investment was after that decline, the cumulative return has been significantly higher than 1,000%).

Conclusion

This article is not really about Nike or Under Armour.

It is about one of the hardest questions we face as investors: when do short-term struggles shift from noise to meaningful developments that should fundamentally challenge our investment thesis?

I think it makes sense to start by thinking about what has made the company successful over the past 5, 10, or 20 years. Are they trying to repeat a proven model or are they doing something fundamentally different? If they are replicating the same strategy, what is holding them back? Is the company dealing with a temporary issue it will eventually move past or has the game changed?

Correctly answering these questions is the first step. Even if you are right, it will not mean anything if you do not have the patience (and conviction) to sit through years of negative price action. As most of us will admit, that is much easier to do in theory than it is to do in practice.

This quote from Charlie Munger (Trades, Portfolio) seems like an apt conclusion:

“Investing is not supposed to be easy. Anyone who finds it easy is stupid.”

Disclosure: Long UA

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct". I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 4.7/5 (13 votes)

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Comments

Dr. Paul Price
Dr. Paul Price - 2 months ago    Report SPAM

At its peak UA sold for about 100x that year's EPS.

Only a fool would have owned it even if they felt the company's future looked bright. Since that late 2015 top the shares (now symboled UAA) has dropped from a split-adjusted $52.90 to $18.23 (down by about 65% while the market hit a new all-time high).

UAA doesn't even look appealing now, after a huge decline.

Nike (NKE) hit $68.20 in late 2015. After a nice recent rebound it closed today at $59.84, almost 20-months afetr setting that peak.

Time is money. Even if a stock eventually comes back... the wasted years, and their compounding effect, are lost forever.

Failure to sell when shares get clearly overpriced is a deadly sin.

There is always another investment bus to get on.

The Science of Hitting
The Science of Hitting - 2 months ago    Report SPAM

Dr. Price,

I think you're spot on - paying a reasonable price relative to intrinsic value is extremely important. Where we differ is how we think about the long-term value of a business. Thankfully for both of us, there's more than one way to be successful in this game. As always, thanks for the comment!

shb600
Shb600 premium member - 2 months ago

What did NKE earn around that time and what was its PE on a trailing and forward basis?

The Science of Hitting
The Science of Hitting - 2 months ago    Report SPAM

Shb600 - Here's a link to Nike's old annual reports:

http://investors.nike.com/investors/news-events-and-reports/default.aspx?toggle=reports

In the 2000 AR, it says the P/E multiple at year end 1999 was 39x.

In the period from 1998 - 2000, net income at Nike was ~$550 million per year.

shb600
Shb600 premium member - 2 months ago

Thanks, still extremely expensive epecially considering the sales decline. No slam dunk unless you can forsee the future.

The Science of Hitting
The Science of Hitting - 2 months ago    Report SPAM

Shb600 - Being able to see the future would make this game MUCH easier!!! :)

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