Tuesday, October 16, 2007

Learning From Eddie Lampert

One of the most talked about value investors today is Eddie Lampert, of ESL Investments and Sears Holdings Corporation. He successfully rescued Kmart from bankruptcy and then later used it to acquire Sears. Along the way he’s demonstrated an extremely disciplined approach to investing, often taking large stakes, holding them for years, and realizing huge gains (~29% annualized since inception).

I have been doing more research on Lampert by looking through some old newspaper articles. Below is what I have gleaned from reading a few older articles on Eddie Lampert, specifically a 1995 Washington Post article.

I could spend this post discussing Lampert’s investment in SHLD, but I don’t think it would be worthwhile. It’s still an ongoing situation and would not make for a complete study. Rather, I think it would be more helpful to learn a bit about the early Eddie Lampert and see how he came to where he is today. First, one of the best pieces of advice I’ve been given is to learn value investing through case studies. Lampert has done this himself, he says that he has studied many of Buffett’s greatest investments by reverse engineering former deals and asking himself questions like this:

If I was looking at The Washington Post in 1973 or ‘74, could I have made the investment Buffett made? Can I understand what he saw?

While highly successful at Goldman Sachs’ risk arbitrage desk, Lampert says this on investing:

I liked the idea of buying something at $ 30 if it’s worth $ 60 as opposed to buying it at $ 59 to sell at $ 60… Goldman was not in that business. We were in the business of buying at $ 59 to be worth $ 60 in a short time.

A long term approach is vital, because it forces you to make sure that the businesses you are investing in are high quality and possess strong moats, capable of weathering temporary downturns and new competition. He puts it best here:

…we have always invested on the basis that whatever we buy, if the stock market was shut down tomorrow, we’d be happy owning the position for the next five years.

Lampert is also keen on investing in restructuring situations. One of his first experiences with this was with Saatchi & Saatchi, but he also used his analytical prowess when evaluating American Express. In the 1980s and early 1990s, missteps by former CEO James D. Robinson III severely hindered earnings. Poor strategy initiatives lead to raising credit card fees on stores and restaurants while also missing out on frequent flyer mile tie-ins.
Eddie chose to study American Express when he saw management work on turning things around by selling off nonessential businesses and refocusing on the credit card business. One of the catalysts leading Eddie to load up on American Express stock was the fact that Robinson was ousted in ’93. He was able to load up at prices around $ 20 to $ 22.50 a share for most of ESL’s position in American Express. At the time of the article, the stock traded upwards to $41.50 a share. In addition, for each of its shares in American Express, ESL also received about $ 3 in dividends and another $ 4 to $5 worth of shares in Lehman Brothers Inc.

On research

We basically ask one question: Is the price at which we are buying the business attractive relative to its long-term intrinsic value?

Like Buffett, Lampert also seems to buy for the long run:

The reality is that when I find something I really like, I don’t normally sell it. That said, there are three possible reasons to sell. One is if the facts have changed adversely — if the economics of the business have deteriorated, if the people running the business have left or are no longer doing a good job. Second is if the price just gets to a point that the valuation is so high we think it is unsupportable and exposes us to the risk of a permanent loss of capital. Third is if there is a better alternative investment, but the burden of proof is always on the new idea.

On investing heroes:

Warren Buffett is Lampert’s biggest influence, mainly for his emphasis on looking at stocks as businesses and at the real economics of those businesses as opposed to just looking at their reported earnings. Then, Lampert also admires Phil Fisher, because he outlines a clear methodology for investment research.

What we can take from this is that it’s important to analyze businesses with the expectation of holding them for long periods of time. Also, you need to make sure that you can be equipped to deal with periods where you may significantly under perform market averages. Many of Lampert’s investors have agreed to 5 year lockup periods with ESL, leading him to have little worry regarding having to sell positions in order to release investors.

There are many investors who simply apply screens to find low P/B, P/S stocks. While this can help you find cheap companies, it can also find you companies that are cheap for a reason: poor management, negative future economic outlook, and so on. Sometimes these are referred to as value traps. Many of these situations could be profitable from a liquidation standpoint, but most individual investors simply do not possess the capital to take control positions to make this a reality. A good example that comes to mind is Concord Camera (LENS)

Great investors should seek businesses where the depression in price seems more temporary, or where there is a catalyst in place for value. With American Express, catalysts were ousting Robinson and spinning off Lehman Brothers helped tremendously in giving management the ability to focus solely on their credit card business.

When looking for restructuring situations today, a simple Yahoo News search will yield many articles. However, it helps if you filter those articles by looking for companies that will be restructuring by selling divisions, spinning off divisions, or changing management. These can be good starting points for profitable investments because they leave you with balance sheet events that can be modeled.

Here are some restructuring situations that I feel may be worth the due diligence:

1. The Limited Brands – Event: selling the apparel division, refocusing on Victoria’s Secret
2. Cadbury Schweppes – Event: spinning off confectionary division
3. Altria – Event: separation of international and domestic business divisions

http://streetcapitalist.com/2007/10/16/learning-from-eddie-lampert/

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Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.