Reader’s Q: Would Graham Consider SHOS (Sear’s Hometown) a Net/Net?

Homestores(SHO-11.01.14-10Q _Final

If we take all the liabilities of $236.576 mil. and deduct from Current Assets of $524.238 = $287.662 mil of net working capital then divide by 22.666 million outstanding shares to have $12.68 per share of working capital minus all other liabilities and leaving out other assets.  Klarman used net-net working capital as  approximating the liquidation value of a company–See Chapter 8 in Margin of Safety.  So current assets minus (current liabilities + all long-term liabilities) = net-net working capital.

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Today the price of SHOS is under $12.68 or $11.90, so yes, the price is trading below net working capital per share, but Graham would not pay more than $8.46 for SHOS given his penchant for a margin of safety of paying no more than two-thirds of net working capital.  Obviously, investors might be concerned with falling same-store sales. On the flip side, deep value investors may see comfort with asset value and the type of inventory.  Note, that there have been a few well-known deep value investors stepping in 3/Q 2014 like Chou Associates (the Canadian Deep Value Investor) Chou Associates Management-inc-top-holdings/ and video lecture: Guest_Speakers/2009/Chou_2009.htm (worth watching).

The above isn’t a plug for investing in SHOS, but pointing out how I think Graham would view investing in the company.

Advice from Wall Street

The third phone call I made that day was to the brokerage handling the stock offering, Montgomery Securities in San Francisco. The institutional salesman there who had recommended the stock was named Rick. Like just about everybody else at Montgomery, Rick was an aggressive pitchman. The word bulldog gets thrown around a lot, but I don’t think that quite captures the level of mindless tenacity the brokers at Montgomery brought to their work. Picture an angry hyena that hasn’t eaten in a couple of days. Now picture someone throwing a bloody porterhouse in front of it. That is how hard these guys sold their deals.

After I introduced myself, I told Rick about the research I had done and informed him as courteously as I could that I would not be recommending the stock.

“The bank is on the verge of insolvency,” I explained. “If they are this new company’s main customer, that is not going to be good for their earnings or their share price.”

Rick barked into the phone, “How old are you, kid?”

I swallowed hard and replied, “Twenty-five.”

“You’ve got a lot to learn,” Rick growled. “Nobody stops me from collecting a commission. I’m not going to waste my time talking to you. I ‘ll call your boss first thing in the morning.”

The line went dead. I stared at the receiver in disbelief. I didn’t understand d what had just happened. I had informed a representative of a prestigious, well-respected brokerage that a stock they were offering had significant downside risk. I had assumed that he would be grateful for my insights, or at least interested in what I had to say. Instead, he had acted like I had belched in his ear.

In reality, Rick was right: I did have a lot to learn. The idea that someone on Wall Street would give a damn about the truth or doing the right thing by his clients was almost laughably naïve.

…….After thirty years of doing this (analyzing investments and managing money), I can tell you in no uncertain terms that buying stocks on the word of so-called experts in the single biggest mistake an investor can make. … This misplaced faith in Wall Street whizzes is a symptom of a much larger and more destructive problem in the investment world: The cult of the guru. Investors of all types–from fund managers to day-traders to mom-and-pop savers hoping to boost their 401(k) accounts –are constantly looking for a market messiah, someone who’s figured out–once and for all-the magical formula for how to beat the Street. It is an understandable but self-defeating desire, because the people who actually possess these kinds of insights almost NEVER SHARE THEM. (from Dead Companies Walking (2015) by Scott Fearon)

BOILER ROOM: I Became a Stock Broker

8 responses to “Reader’s Q: Would Graham Consider SHOS (Sear’s Hometown) a Net/Net?

  1. Well to echo Marty Whitman, one question is how good are those current assets?

    As well, there may be hidden assets–under market longterm leases in great locations or hidden liabilities, the reverse, over market long term leases in lousy malls. Although after all the turmoil of recent years, perhaps Lampert had already sold off the easy things.

  2. I think Geoff Gannon once said that if you find a net-net, it’s close enough, and you have a basis to start looking.

    The company is going nowhere fast, but then that’s what we expect from a net-net.

    I’d appreciate a little help here. According to a 13D
    http://www.sec.gov/Archives/edgar/data/923727/000119312514289560/d769562dsc13da.htm
    ESL Partners (Edward Lambert’s investment vehicle) have “control” of around 46% of the shares. Does that sound an accurate statement?

    If so, then it’s an interesting opportunity to coat-tail an activist. As I recall, although Buffett sometimes took a controlling interest, he also did some coat-tailing.

    Also, book is $426.7m, and the market cap is $270.6m, so the PBV is 0.63.

    Interesting situation, John.

  3. My short answer: avoid retail altogether. It`s too hard. Clever math
    is redundant.

    To my mind, the most important question you can ask yourself about
    investing is this:
    how can I reduce the probability that I make an investment mistake?
    The best technique in my opinion is NOT the margin of safety. It is to avoid industries in which the world`s best value investors have demonstrably bad track records because there is a fundamental flaw in the industry: it is too fast changing and therefore unpredictable. Ackman and Buffett have notched big errors in this industry, so what makes us think we can do better?

    I think of retail as an entity that creates a giant cognitive availability bias
    in humans: we see stores every day, and they are simple businesses, so we think we understand them. But just because shops are all around us does not mean we can predict with fair accuracy their medium to long term performance.

    Stick to slower changing industries with good economics — one of the main lessons of the See`s Candy purchase.

    Investing is not what you know — it`s how you think.

  4. SHOS sold at a high of around $55 in May 2013, and is now down to about $12. Yikes.

    I actually think it’s a great find by John. He’s certainly been snuffling around! If we want to go down the Deep Value route, then it’s a quantitative strategy, not a qualitative one. You buy lousy businesses at a price so cheap that probability dictates that a basket of them will do well. The shares could still go much lower. They could even go to 0. Those are the breaks when you pursue that kind of strategy.

    BTW, SHOS has a market cap of $270m. Its last quarter sales were $565m.

    I remember a recent post by John talking about Greenblatt’s purchase of Sears vs JCP (or was it the other way around)? The whole crux of the argument was that one was cheaper than the other, and had less debt. The argument was a very simple one.

    SHOS looks like it might be an even better bet than Greenblatts original. The fact that you’ve got Lampert on your corner increases your odds.

  5. You raise a good point about staying away from retail. In fact, Buffett came to grief when he went into that Baltimore department store. Buffett’s example lead me to question Lampert’s investment. To paraphrase Buffett, when a manager with a great reputation (investor in this case) runs a business with a terrible reputation, the business’ reputation stay intact.

    Thought question tho, how does See’s escape the standard retail traps? I know what I think.

  6. Again it is how you think.

    See`s is not a retail business, is it…

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