Selected excerpts from the Knowledgebase -4

Selected excerpts from the Knowledgebase -4

I’ve decided to do a daily small excerpt from the Knowledgebase as sort of a thought for the day. In many cases I have added commentary, extra thoughts, or small updates. I hope you’ll find them interesting.

Saul


Here’s the fourth:

To get an idea of the problems of falling in love with a stock and refusing to admit a mistake, and incidentally to see how well my method of evaluating stocks works, here’s a post I made on the XONE board back in 2013 when MF was touting XONE as the next greatest thing and the price was $59.

“Why would a stock with negative earnings, that has never had a profitable year, be selling at such a huge inflated price. Granted, some is about prospects for the future, and some is the 3D printing hype, but some must be hopes of the company being acquired. Look, last year they lost $10.2 million on $28.7 million of revenue. That’s a negative margin of 35.5%. It means they lost 35 cents on every dollar of sales!!! To put it simply, revenue was about $29 million and expenses were about $39 million! They lost 20 cents this quarter in spite of great revenue. Say that by magic they overcome the loss in the next three quarters and finish the year with 25 cents profit. I’m not rejecting the possibility. With that miraculous result, they’d then be selling at over 200 times earnings. (220 times to be exact)…What can I say? I think the technology and the company may have great futures, but the stock may be miles ahead of itself. Miles and miles and miles. I may be totally wrong, and greatly underestimating, but it’s worth considering those figures.”

That post got all of two rec’s! No one on the XONE board, which was a very active board at the time wanted to hear what I said, because they were married to the stock. XONE’s price dropped to $6.50 in 2015 (from $59.00 when I wrote that), losing almost 90% of the value it had had when I posted that evaluation three years ago. It was finally sold by MF in August 2015, down 82.9% from the recommendation.

And then there was WPRT. I sort of became famous when I was drummed off the WPRT board by angry people because I warned that the revenue would have to quintuple before they could even break even. You wouldn’t believe the bitter, sarcastic, and furious comments I received because I pointed out that their beloved company simply couldn’t ever break even in their lifetime. The price was $32 at the time, and it was being strongly, STRONGLY, recommended by the MF at the time. As I remember, I explained losses were well more than revenue, so that their expenses were more than double their revenue, and they only had 30% gross margins, so revenue even rising 100% would only cut a fifth off their annual losses. The company was predicting revenue up all of 15% for the next year! Nothing! But nobody was willing to listen! The price is $1.61 as I write. From $32.00 !! It has lost 95% of its value.

A big problem is that the ones that go down keep sopping up more and more of one’s total investment as many people “double down,” “reduce my average cost,” “buy at better value points,” and generally put in more and more money in at lower and lower prices. For example, on the WPRT board, when the price dropped from $32 to $25 lots of people felt it was a bargain, and bought more, and at $20 “doubled down,” and “doubled down” a second time at $15, etc. It’s hard for people to see a stock they believe in go down to what they think are ridiculous levels without buying more, especially when it’s misleadingly still labeled a “Buy.” (Remember, it’s at $1.61 as I write so even those $15 purchases are down almost 90%).

What’s the message of this post? Don’t get married to positions! Especially if they are losing gobs of money, with no clear path towards profitability. Be willing to consider contrary arguments and evaluate them. Only then, after careful consideration, consider adding to a falling position.


You may find a contradiction between my feelings about XONE and WPRT as expressed above, and my investing in a company like Shopify, which is still losing money. However there are significant differences: To start off with Shopify’s losses were 3.5% of revenue, while XONE’s were 35% of revenue!!! And WPRT’s losses were over 100% of revenue!!! Second, Shopify has been regularly growing revenue at over 90% year over year. That means that Shopify has been purposely spending all their profits on massive growth to capture their field, and that they could slow growth tomorrow, just a little, and show a profit instead of a loss. There is little or no relationship between the situations

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Hi Saul:

what does that prove?
at least it would be interesting to see some opposite examples- like ‘I said it would be bad but it turned out good’ or ‘I said it would be good but it turned out bad’.
and see the accuracy. But would that prove anything?

there are pros and cons and the market weights it in differently.

I know you will not buy UA. Too expensive. But many seem to value the future of UA a lot more than you do and the stock price has not dipped.

tj

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Hi to,

But many seem to value the future of UA a lot more than you do and the stock price has not dipped.

It’s down about 25% over the past year or so. Perhaps it’s a good buy now.

The point Saul tries to make is that there are alternatives to such companies that have better valuations, Skechers for example, which is down a lot more than Under Armor the past year. Skechers’ valuation is a lot better as well.

Not all investments Saul makes go up. But buying companies at good value points and growth prospects has helped him get better results than chasing companies with high valuations.

DJ

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Great post Saul. I remember those days when you ran into trouble on the boards with WPRT and XONE. It was a great call on your part. Though I have to confess I didn’t listen to you as well and paid the price later :slight_smile:

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Saul,

It was your posts on XONE and WPRT boards that really helped form my thinking when looking at and evaluating companies that I want to invest in. I again want to thank you for that. I applied the same thinking to LNKD as well, and got out way before the big drop.

I am much happier with my portfolio and returns, and one of the main reasons is by applying what I have picked up from reading your posts as well as many others on this board.

Thanks Again!!

Kevin

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Thanks Kevin and FoolChandra for your kind words. Glad I was of help to you.

Saul

Thank you Saul.
I have learned a lot about investing by reading your posts.
And learned more yet again today.
How to value a company losing money by the % of revenue.
Is that just from the number of cents per share loss? How do you calculate that?
Thanks again
MC
Long
UBNT
SKX
ATW
s&p 500 index

Thank you Saul. I have learned a lot about investing by reading your posts. And learned more yet again today. How to value a company losing money by the percent that the loss is of their revenue… How do you calculate that?
MC

Just as a company making a profit gives you net income (in dollars) and divides that by the number of shares to get earnings per share, a company with a net loss tells you how much the net loss is in dollars. You divide that by the revenue to find out what percent of revenue the loss is. For example, let’s look at HUBS, which is still losing money. In the press release for the last quarterly report they said:

Non-GAAP operating loss was ($2.5) million for the quarter, compared to ($5.7) million in the second quarter of 2015.

and they also said:

Total revenue was $65.0 million, up 51% compared to the second quarter of 2015.

Thus operating loss of 2.5 million divided by 65.0 million in revenue, equals 0.038. So loss is 3.8% of revenue. It’s a very simple calculation.

You might also take into consideration that the loss of $2.5 million was down from a loss of $5.7 million a year ago, and that revenue was up 51%, so the trends to get rid of that loss are strongly in the correct directions.

Hope this helps.

Saul

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Saul,
I wished I’d listened to you about ZOES 6 months ago. I thought it was at a growth inflection point, but down she went. I have just enough to keep an eye on it, and I will probably get back into it after it gets significant earnings traction at a better price.

That said, one thing I have learned from you is admitting my mistakes and shedding my losers MUCH faster than I used too.

It’s kind of interesting tracking ones portfolio accuracy. I am sitting at 65% accuracy for picking my winners correctly (beating the S&P), and 80% accuracy of selling actual losers (making sure they lost more than the S&P).

Have your ever tabulated those stats for your portfolio?

Best,

bulwnkl

Have your ever tabulated those stats for your portfolio?

For anyone with a longer term perspective, they seem like pretty meaningless numbers. Is it a plus to sell out of something which goes down the next month when it goes massively up a year or two in the future? It could be, if you have a system for buying it back in the dip (which I disbelieve), but it is the long term performance which counts.

1 Like

tamhas,
I typically hold 2-3 years, so my average stock beating the market is a significant win. Although I don’t have the returns Saul does, I have averaged 8% better than the S&P for 20 years. I rarely buy on dips, but will make an exception when thesis is exceptionally solid such as it was this year with SE (+ 88%, 10 month holding time) and OKE (+63%, 1 year holding time). Is that significant to you? That said 90% of the time, I DON’T buy on dips, and I wasn’t suggesting anyone else buy on dips.

I think it is really, really important to gauge our investments results and try to improve them over time. Why do you think your accuracy for long term investments has to be related to short term gyrations of the market? I’m not sure why you read that into my post.

bulwnkl

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is it a mistake if it doubles a few times in say…3 or 5 or 10 years?

who would be right and who will be wrong then?

tj

Thanks Saul.
That makes a lot of sense and is a big lightbulb for me.
I still don’t like buying companies running at a loss but will continue to study.
I missed Amzn from 100-800 due to a lack of understanding how to value companies losing money.

I’m not sure what you thought I meant, but what I was commenting on was collecting stats for something that one sold and caring whether it was up or down. Perhaps one sold it because there seemed like a better opportunity. Perhaps it went down for year or two and then went up through the stratosphere. Is that a win or a loss? None of that matters because it is not in your portfolio any more.

None of that matters because it is not in your portfolio any more.

Not true if you wan’t to evaluate your trading (decision making) effectiveness.

Denny Schlesinger

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I get the point you are making Saul (don’t dwell on the past because only the current situation is now relevant) but I am with Denny on this one. The present is the present and what’s done is done but future action may be improved by the occasional glance at the chart of a once-held company and a smile. Or a sigh.

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Once again, it comes down to performing your own due diligence. It is vitally important to understand your source if you are acting on a recommendation.

TMF provides a valuable service for (mostly) free or reasonable fee. But they live by a “buy and hold” mantra. This is not just an investment philosophy, it is at the foundation of the companies strategy. Anyone who’s hung out here at TMF for a while will note their extreme reluctance to issue a “sell” recommendation on a company they have previously strongly touted. A “sell” violates the underlying thesis of the TMF business. If the company has not gone out of business, there’s always hope for recovery in the distant future - if you just hold out long enough.

I’m not really out to take a shot at TMF, I am simply suggesting that you need to be cautious. I’m sure, in the background, TMF analysts run all sorts of sophisticated screens to help them identify potential picks for their various services. And for the most part I hold their analysis in high regard. But be forewarned they have a business imperative that makes “sell” a dirty word.

If you pay attention to Cramer or Zacks you will see a much different attitude in operation. I didn’t say better, just different. My admonition still holds: perform your own DD.

And, be willing to perform it again periodically. If the stock takes a sudden dive, it behooves you to understand what’s driving it.

Saul is the first to admit that he is not infallible. In fact, my observation is that Saul constantly challenges himself on his decisions. For example, Saul for a long time was a staunch supporter of SWKS, then not long ago he completely reversed himself. Be willing to ask yourself if you would buy the stocks you currently own again, today. If the answer is 'no" ask yourself why you still own it. Maybe there’s a good reason, like it is already a large position so you won’t risk any more capital. OK, that has to do with your personal situation, not the company’s prospects. But if the answer is “no” because you’ve lost confidence in management (my analysis of BOFI), or market saturation (my analysis of GPRO), or whatever. If it’s a fundamental business problem, it’s probably time to put your money in a more promising investment.

If you’re torn or undecided, you needn’t sell the entire position, maybe just trim it and reinvest elsewhere. The point is, recognize that you are responsible for your portfolio. Own your decisions. Make your decisions afresh irrespective of what you decided in the past.

Finally, one of the primary lessons I’ve learned from Saul (this board really) is have a decision support methodology. If you have no method by which you perform your analysis and evaluation, you have no basis for comparing one company from another - every decision becomes an emotional gut decision.

I think as humans, we tend to stick by our emotional decision much more strongly than logic driven decisions. Hence the tendency to fall in love with a stock (not necessarily the company) in spite of all evidence to the contrary.

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“It is vitally important to understand your source if you are acting on a recommendation.”

brittlerock:

when you buy anything you certainly have to understand what you are buying and why you are buying it. That is the same thing when buying a stock. The value of a stock however is varying in time depending on the mood and the perception of the day. That is all very flimsy in a sense. Many have this constant attention and this ready attitude to flee at the slight sign of trouble.
For the longer term investor, the results of speculation do not concern him or her too much. S/he rather wants to see how the business is progressing and its direction for the future. When the farmer sow the seeds, s/he expects crop the next spring. There are risks of bad weather but most of the time s/he gets his or her crop.
Certainly a business is less predictable than farming but you have this picture.

The difference between investors come from their different outlook in time. It takes time to bring up a business on track and to reap the rewards of what has been sowed. A good business should not break over speculation. Its stock might temporarily but if the business works the stock will reflect that in the long term.

A lot of the talk are about timeframes (a few months or a few quarters or even a few years) that are too short to know how much traction a business really has.

Buying and selling within these short timeframes are for me trading. You can certainly make money in trading on the current mood but I would not call that investing.

Due diligence is great but it will not tell you when you should sell and when you should buy back a stock in the shorter term. It should tell you if the business is worthwhile investing in.

I think once you have this view of investing you will not attach so much importance in ‘knowing when to sell’. You will sell it when you need the money. For an investment you should not need it now.

tj

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