On The Two That Got Away
“The investment shown by the discounted-flows-of-cash calculation to be the cheapest is the one that the investor should purchase – irrespective of whether the business grows or doesn’t, displays volatility or smoothness in its earnings, or carries a high price or low in relation to its current earnings and book value.”
(Read Warren Buffet’s 1992 Annual Letter to Shareholders)
Lately, I’ve been thinking a lot about Fisher and Munger and their influence on Buffett. If I have not said it before, let me say it now: I believe both men’s influence on Buffett’s investment decisions have been overstated. I do not mean that as a slight to either man. They both have impressive records of their own, and they both offer a lot for investors to study. Phil Fisher and Charlie Munger are two of the greatest investment thinkers of all time. Besides, this post is not about the influence these men had on Buffett. This post is about investment mistakes I have made – mistakes I would not have made had I heeded the advice of Fisher, Munger, or Buffett.
This post is, at least in part, the result of the time I spent at Jason Bond’s blog over the weekend. That may not be obvious; nevertheless, it is true. I’m currently working on a three part podcast series on spotting great companies. I’m also in the process of reviewing two books: Phil Fisher’s “Common Stocks and Uncommon Profits and Other Writings” and Charlie Munger’s “Poor Charlie’s Almanack”. Obviously, these projects are closely related. That fact has been reinforced by two activities I engaged in this week: rereading Warren Buffet’s annual letters and visiting Jason Bond’s blog. Having done these things, I knew I had to write this particular post today.
Two weeks ago, I posted “On Blogs as Public Records”. In that post, I wrote:
“We’ll go over my mistake. Think of it as an autopsy. We’ll determine the cause of my error, and look to prevent it from creeping into our thinking in the future.”
Not surprisingly, both of the biggest mistakes of my investing career have been errors of inaction. However, these errors were not passive. When analyzing decision making, inaction must always be considered an action. A choice is made in either case; whether the outside world sees the results of that choice or not is irrelevant to an analysis of one’s own judgment – or misjudgment.
Three years ago, I failed to buy shares of Building Materials Holding Company (BLG). A year ago, I failed to buy shares of PetMed Express (PETS).
In each case, the stock was clearly undervalued. In each case, I did an intrinsic value analysis and compared the margin of safety to all possible alternatives. In neither case, did I find a possible alternative that had a margin of safety even remotely comparable to that of the stock being considered.
I will spare you the details of my analyses. It is sufficient to say that my best estimate of the value of each business was several times the market cap of that business. So, why didn’t I buy?
I failed to heed the tenth of Fisher’s ten don’ts for investors: “Don’t Follow the Crowd.”
It may have been a different crowd in each case; but, my mistake was the same. I lacked the courage to act on my convictions. I allowed myself to be swayed by inconsequential considerations about which I knew nothing. Even worse, I let these considerations outweigh those matters of real import – matters which I knew a great deal about.
In the case of BMHC, I let macroeconomic considerations keep me from buying a cheap stock. This might have been the best course of action, if the margin of safety present at that price was just barely sufficient to qualify as an investment. Then, I would have been justified in not buying the stock, because there were real economic threats about which I knew nothing. However, no economic threats could erase the margin of safety present in those shares. I knew that, and still I didn’t buy.
My mistake in the case of PetMed Express was a very simple, very stupid one. I paid attention to traditional metrics such as price – to – earnings and price – to – book value. I knew the intrinsic value of the company was many times the current market cap, and still I didn’t buy.
Why? Because the P/E ratio was too high. That’s not what I told myself, of course. But, that was the real reason. As a value investor, I was used to low price/earnings, low price/book, and low price/cash flow stocks. PETS was unlike those stocks. Even so, I knew it was a bargain, and still I didn’t buy.
PetMed Express is an example of a great business. It fails to meet several of Fisher’s fifteen points. There are management concerns and legal concerns. But, those are of little consequence.
They are mere pebbles on the scales when you consider the economics of the business. PetMed Express is about as good a business as there is. It is a fast growing business in a highly fragmented, slow growth industry. The barriers to entry are high. The economies of scale are enormous. PetMed Express buys lots of cable advertising; if the company’s management is smart, it will buy even more. Consumers know about 1 – 800 – Pet – Meds, they don’t know about competitors. The company controls a very small part of the market; yet, it will almost certainly dominate the market in time.
PetMed Express has a competitive advantage like no other. I knew that. I did the math. It wasn’t even close. Still, I didn’t buy. I didn’t listen to Buffett’s best piece of advice:
“The investment shown by the discounted-flows-of-cash
calculation to be the cheapest is the one that the investor should
purchase – irrespective of whether the business grows or doesn’t,
displays volatility or smoothness in its earnings, or carries a
high price or low in relation to its current earnings and book
value.”
Don’t make the same mistake.