F Wall Street Investment Performance II

October 31, 2008 by Joe Ponzio

Some of you have been accusing me of becoming short-sighted here on F Wall Street, particularly because I dumped a lot of positions rather quickly. The problem with “blogging” is that I am (and your comments are) only as reasonable and good as the perception of the reader. So, I’m going to justify the sales in this post, bring readers up to speed on the portfolio…and this is the last time I’m going to discuss the topic.

If, after reading this post, you think I’m fixating on the short-term, feel free to send me an e-mail to spark up a discussion.

On Selling Stocks To Raise Cash…

Let me pose somewhat of a rhetorical question, though you can answer it in the comments if you’d like: When buying a stock, what is the difference between taking the money out of cash, or selling a seemingly mediocre opportunity to raise the cash?

Why not invest your assets in the companies you really like? As Mae West said, “Too much of a good thing can be wonderful.”

Save Landry’s and AEO, I sold out of positions that I didn’t necessarily “really like.” I sold Adobe and Apple. Why? Let me bring up a quote from the August 9, 2008 Investment Performance post:

Adobe is fairly priced but I think it is a solid company. If I run out of cash and need to sell something, I’m happy to sell Adobe. If I don’t need cash, I think my money is better parked in Adobe at $34 and change than in a money market for a few years.

In this case, as the markets began to melt down, I felt that I’d have a chance to find companies I “really like” and wanted to have cash on hand to pull the trigger. What is the problem with dumping mediocre positions at mediocre prices? Why do I think they were mediocre opportunities? In my sphere of confidence and competence, if I had felt more strongly about these positions, I would have gladly invested 20% of the portfolio in them.

As an example: Though they are both down considerably from their highs, I never considered selling Johnson & Johnson or Wal-Mart, again keeping this quote from the same post in mind:

If you find four to six Johnson & Johnsons and Wal-Marts trading at discounts, you need not worry about owning anything else. You can put 20% or 25% of your portfolio into wonderful, rock solid businesses selling at discounts and walk away from your portfolio for years.

Selling Out of Landry’s

Landry’s was a workout that went bad. Plain and simple – no need to hang around.

Reassessing American Eagle Outfitters

While I don’t believe that valuations change rapidly based on price movements or that we should consider the current markets in investing, I do feel like I overpaid for American Eagle. Assuming I’m spot on with my valuation (which we never are, which is why we must demand a margin of safety), what could I expect from my American Eagle investment?

Buying at $26 when the value is just $18 or so, the only thing I can hope for is that the value eventually creeps back above my price point, and that I eventually break even on my investment. But note the key word: Hope.

Optimism and pessimism have no place in investing. From a realist standpoint, I’m not willing to wait for American Eagle to grow to that $26 level, nor am I willing to hope that “some fool” is willing to pay $26 for an $18 business like I did.

Which is the better allocation of capital: Hope that time will correct your mistakes, or admit your mistakes and move on to better opportunities? Remember: You don’t have to make it back the way you lost it.

Perhaps there are other solutions that make more sense than mine; however, wishful thinking – and its usual companion, thumb sucking – is not among them.

I don’t know if Buffett was talking about admitting mistakes and taking losses in that quote, but it is quite appropriate when you overpay for a business and then rely on time and hope to correct your errors. I’m not willing to suck my thumb, hoping that I didn’t make a mistake when other opportunities are so clear.

Now, you can make the case that AEO was not a wonderful business, and I’d agree – that’s why I didn’t invest 20% in it. I still think it’s a good opportunity…but at the right price. $26 is not the right price, and if it falls to $7 or $9, I’d consider buying again. Still, at $7 or $9, I’d have to first ask if there are any companies I “really like” out there at attractive prices. If not, AEO is an option.

How The Economy Affects The Valuation

The economy affects the valuation to the extent that AEO’s cash flow will likely pull back to a lower level, which would then be the starting point for a new valuation. We can’t use last year’s cash flow as a starting point for projecting future cash flows because future cash flows will likely have a lower starting point when the dust settles.

Lower cash flow means lower valuations. In this case, we have a lower starting point than we projected, and future cash flows will all likely be lower than projected as the business recovers from taking a step back.

It’s paramount to remember that these things are actual businesses. The fact that AEO generated $x of cash flow last year doesn’t mean it will necessarily do so in the future. Management will have an uphill battle to get people in the stores spending money, and they won’t rush back to do so. This is business, no matter how rosy the spreadsheet says the past was…and business is tough.

Maybe I’m wrong again on AEO. Maybe it really is a $25 or $30 or $70 per share business. And maybe you can find confidence in buying it today at $11 or holding it from $26. That’s what makes investing so great – the fact that we all see value (or a lack of value) in different ways.

This is my thesis, and the reason that Joe Ponzio sold American Eagle Outfitters. If you personally see more value or disagree, load up the truck. Don’t let me sway you one way or the other…you’ll never sway me just the same ☺.

The F Wall Street Portfolio

Excluding LNY which was a workout that went bad, I sold $18,000 or so worth of stocks, and turned around to purchase $25,000 worth of two companies – $20,000 of MMM and $5,000 of NTRI.

It’s a tough market for all long-term investors; and, because we’re looking to beat the markets by five or ten points a year over the long-term, that means we hope to lose less when the markets are falling, make money when they are flat, and hope to keep up or out-perform when they are on the rise over the long-term.

Since June 25, 2007 – the day the site started – the F Wall Street portfolio is up 2.9% versus a 30.2% loss in the Dow and a 35.3% loss in the S&P 500. The relative out-performance is still quite stunning. (There’s something to this “buy good businesses at attractive prices” hullabaloo.) A $100,000 investment in F Wall Street’s portfolio would be worth $102,898 as of 10/31/2008, versus $69,840 in the Dow and $64,681 in the S&P 500. (I didn’t have time to run it against the DIA or VFINX like I did in this review.)

We’re still sitting on about 28% in cash, waiting for another fat pitch from the markets.

For you visual folks:

Of course, the portfolio has only been running for about 16 months – way too short a time to judge performance. Still, I’m quite pleased with the results.

Keeping the long-term in mind…no matter what happens in the markets, we’re not going to look at the performance again until June of 2009.

I hope that clarifies things and satisfies curiosities. Happy Halloween!

A Note From Joe Ponzio

This section is for comments from F Wall Street visitors. Do not assume that Joe Ponzio agrees with or otherwise endorses any particular comment just because it appears or remains on this website.