By: Ben Claremon | Principal & Portfolio Manager
We are often evaluated by our current (and potential) partners based on our most glaring successes and mistakes. It is really easy to remember the stock that went up 3x or the one that was down 75%. But, what might be even more interesting to investigate—and could provide an even better barometer of our investing acumen—is what happened after Cove Street sold a stock. Or what about the ones for which we went the research distance, but passed?
We are value investors and somewhat annoyingly that means we are going to be early more than we would like to be. Given our conservative nature and our capital preservation philosophy, it is also inevitable that in some cases we will sell a stock too soon. Our investment process virtually ensures we will continue to sell stocks when they surpass our estimate of intrinsic value and at times, in hindsight, that will look like a mistake.
As a result, we keep track of the performance of the stocks we sold so that we can improve upon our process. If we end up selling before a large rise in the stock, we think it is valuable to perform a post-mortem on the investment to determine if there were key variables we missed or if we simply underestimated certain aspects of the company’s business, value or people. We will own up to these “mistakes” and add to our diligence efforts in order to avoid making them in the future. Out of sight should not mean out of mind.
On the other end of the spectrum are the stocks we sold really well. Once out of the portfolio, these securities don’t show up in any performance reports and aren’t on anyone’s list of stocks to discuss with us. In fact, we rarely get kudos from consultants for selling a stock before it went down 50%. But, just like we think it is valuable to understand why something went up a lot after we exited the position, we also take note of situations in which our sell discipline proved to be prescient.
Case in point is Francesca’s Holdings Corp. (ticker: FRAN), a company that we have owned off and on in the past. I won’t get deep into the litany of reasons for why we sold the stock but suffice to say that the revolving door at CEO and the company’s mall exposure were at the top of the list. On a factual basis, after one of many disappointing results, we bought the stock at around $10 in August of 2015 and sold the stock after a very nice run—at around $18—in January of 2016.
Fast forward to today and after reporting its Q2 numbers, the stock is down more than 30% and currently trades under $4. Now, we are not going to claim that we saw negative 13% same-store-sales numbers coming. On the contrary, in Q3 and Q4 2015, the company printed positive 4% and 11% same-store-sales numbers, respectively. What we did see was that brick and mortar retail—and especially within malls—was going to be under continued pressure due to the shift to online commerce. We have also come to realize that there are very few retail concepts—certainly a lower number than are publically traded—that have any sort of redeeming brand value. Additionally, at almost $18, the valuation incorporated a somewhat rosy outlook for the future that our research suggested was overly-optimistic. Having mentally coded it as a “Graham Stock,” we woke up every day with the thought of selling it near intrinsic value…and we had the discipline to do so.
At the end of the day, the reality turned out to be far worse than we expected. But, our process and downside-protection-oriented mindset helped us avoid holding onto a major loser. This is just one example of many but it serves as a reminder that, when evaluating a money manager, there is more to consider than simply focusing on trailing performance numbers.
