Weight Watchers (WTW): Mistakes Made Over 4 Years of (Emotional) Volatility

I lost a lot of money in Weight Watchers. Let’s look at why that was.

 

As I write this article, Weight Watchers (WTW) stock is at $44.30 a share.

 

I bought my shares at $37.68 a share in 2013 and sold them (in March of 2017) at $19.40. So, I realized a loss of 49%. I also tied up money for about 3.5 years. During this same time period, the S&P 500 returned about 12% a year. I probably could have found something else to buy that would have returned 10% to 15% a year like the overall market did.

 

So, we have two types of losses here. One, is the lost money. That was about 50% of my investment which in turn was about 25% of my total portfolio – so, a loss of about 12.5% of my portfolio. The other loss is time. Over 3.5 years (the length of my Weight Watchers holding period), an investment that moved about in line with the overall market would have grown to about $1.50 for every $1 I invested. This means my decision to invest in Weight Watchers instead of something else wasn’t really a loss of 49 cents for every dollar I invested. It was more like a loss of 99 cents for every dollar I invested (49 cents in capital losses plus the 50 cents in forfeited compounding).

 

So, that was the cost of my mistake. For each dollar I could have invested in something else and thereby ended up with $1.50 at the end of 3.5 years, I instead put that money into Weight Watchers and only got 51 cents back. The difference between a $10,000 investment in a hypothetical “something else” (like an index fund) and a $10,000 investment in Weight Watchers would be: $15,000 in the something else or $5,100 in Weight Watchers. So, about a $10,000 difference on a use of $10,000. Talking in terms of $10,000 isn’t hyperbole. Remember, I put 25% of my portfolio into this stock to start.

 

This may sound like an odd way of looking at the loss, but the fact this investment tied up money for 3.5 years is also important.

 

Now, we know what my losses were. But, what were my mistakes? I want to separate the evaluation of my investment into two parts. Did I make a mistake in my stock selection? And if so, how bad was that mistake? And then, did I make a mistake in my “hold” approach? And, if so, how bad was that mistake.

 

In an earlier article, I talked about how my sell decisions haven’t added any value over time. My stock selection over the last 17 years has been good. My actual investment performance has been no better than my stock selection though. None of my performance advantage over the stock market as a whole has come from selling at the right time. All of my outperformance has come from picking the right stock at the right time when buying.

 

My experience in Weight Watchers fits this pattern.

 

My timing was bad.

 

Let’s start with my buy timing. I bought Weight Watchers at $37.68 a share. When I put out my report on the stock – recommending it to subscribers – the price was $32.12. The timing of the report was based on factors like how long it took me to research and write about the company in enough depth to publish a 10,000 word analysis. This means the report dates couldn’t be precisely “timed” by me for price reasons. It often took about a month between the time my newsletter co-writer (Quan) and I decided we wanted to pick a certain stock and when we released the report. Here, we can see that my own sense of timing didn’t help. I paid $37.68 a share for my stock while subscribers could have followed me into the stock at $32.12. So, right there my sense of timing made me pay about 17% more for the stock.

 

This isn’t always true. I can find reports where I bought a stock I also recommended for the newsletter and yet I got a lower price for my shares than the price shown on the report sent out to subscribers. The best example of this is Frost (CFR). It’s a stock I still own now.

 

I’ve looked at all my past trades. And, it’s true that the exact timing of my buys may add value. However, the exact timing of my sells definitely does not add value as we’ll see right now.

 

I sold my Weight Watchers shares at $19.40 in March. We are now six months later (in September), and the stock is at $44.30. So, I missed out on a gain of 128% in half a year. That’s terrible timing.

 

I don’t want to cherry pick here. So, I have to go on a bit of a tangent and mention I sold something else (B&W Enterprises, which is the “rump” spin-off of my BWXT position) at $10.22 a share at the same time I sold Weight Watchers. That stock plunged from $10.22 in March to $2.63 a share now. So, that’s a 74% loss in 6 months that I managed to miss out on by selling.

 

Here, I want to sidestep a discussion of luck with a simplification. We could pick certain days on which Weight Watchers was very cheap or very expensive and imagine I might have bought more at that moment or sold out at that moment. This is backward looking and really all it tells you is how lucky I might have been.

 

There’s one way to do this without any consideration of lucky timing. It’s the simplest approach. I did a whole report on Weight Watchers (Focused Compounding members can read the report in the Library). That report wasn’t released on some specific day because I felt the price was perfect at that moment. I only had control over picking the stock. I didn’t have control over the exact price at the time we released that report. In fact, I know Quan and I were working on that report for well over a month before we released it. So, we can use the not precisely timed price of $32.12 a share that subscribers would have seen when I picked Weight Watchers stock in 2013. And then we can just assume these subscribers did the simplest thing possible: they held every share of the stock they bought from the day I released that report right up to the present day. That means they bought at $32.12 a share 4 years ago and they are still holding at $44.30 a share today.

 

How much of the my own loss could these subscribers have avoided? An investment of about $1,000 needed to – over the last 4 years – have grown to about $1,480 today to keep pace with the market. An investment in Weight Watchers didn’t do that. If you bought the stock the day I released my report on it and held it till today, you would now have about $1,380 instead of $1,480. So, again, there was some opportunity cost here. If you bought Weight Watchers when I released the report and held it till today, you’d be looking at an 8.4% annual return over the last 4 years. The market did better than that. So, Weight Watchers would’ve still been a loser. But, it would’ve been a very small loser.

 

Instead, I lost a lot by buying at over $37 a share and selling at around $19 a share.

 

It was a wild ride. So, my result could have been even worse. Weight Watchers dropped as low as $4 a share in 2015. That low point was reached about midway through my investment. So, the first half of my investment in Weight Watchers was a roughly 18 month decline from $37 to $4. That’s enough to scare most people out of any stock.

 

Not everyone. Here is one blog reader who emailed me to say he was sticking with the stock:

 

“I have great faith in your analysis of Weight Watchers. I (also have) experience in the weight loss industry myself and can really see the efficacy of its system as well as the trajectory. 

 

I have also made considerable personal investments of a large portion (of my) personal savings in WTW, and was in for a real roller coaster ride… But…I held firm to my beliefs that it is a great company (albeit with a lot of debt ). 

 

I know the metrics have changed greatly since your last article (and Punchcard’s article) on it, but also know that you held on to your guns despite market irrationality in 2015 when it got sold down just before the Oprah announcement.”

 

This reader attached a table showing the value of his shares in Weight Watchers. That table shows the price starting at $32 a share when he bought in and then declining to $4 a share before rising to about $11 a share when he sent me that email saying he had “great faith” in my analysis of Weight Watchers.  I sold out at $19 a share. When I announced that sale, this reader emailed me saying:

 

“I am just curious about the WTW sale, since WTW has announced growing subscription numbers and has Oprah as a Board Member, so things look rosier than last year.”

Presumably, this “avid follower of my site” (feeling things were looking so rosy) has held on to his shares to this day. If so, the “avid follower” has done much better than the gutless leader (me) who came up with the idea but did not have the stomach to see it through.

If so, he would not be the only person who followed me into Weight Watchers and did better than me.

On January 7th, 2017 “Munger Fan” wrote an article on Seeking Alpha entitled “Weight Watchers Provided a Valuable Lesson in Stock Watching”. It’s a good article. I recommend you read it.

 

The brilliance of this article is in its simplicity.

 

It’s not really about doing a detailed analysis of Weight Watchers from scratch. It’s more about reading what I wrote – at a much different price – and then checking what is still true about the company. This allowed the author to make a turnaround bet – with much better odds – than my original (faulty) “wide moat” investment.

 

When I made my investment in 2013, I paid what I thought was a reasonable price for Weight Watchers. It was about 8 times EBITDA when the EBITDA margin was near a high level. So, this is a lot like paying an unleveraged P/E of 15 for the stock. The actual P/E on Weight Watchers was around 8 when I bought it. But, that’s misleading because the stock was very leveraged. In truth, I paid an average (debt adjusted) price for what I believed was an above average business.

 

At a later date, someone like “Munger Fan” could buy into the stock in a higher leveraged situation, but at a much better price. On a normalized basis, Weight Watchers was really cheap in January of this year.

 

Let’s take a look at this Seeking Alpha article:

 

“The best known recommendation a few years ago was given by Geoff Gannon and Quan Hoang…The report in itself was extremely well-researched…”

 

I’m not including that quote to toot my own horn. I’m including it to make a point. My well researched report on Weight Watchers got me a big loss. Someone else who was braver in the application of the investment could piggy back on existing research without needing to reinvent the wheel for himself.

 

There’s a lesson in there for you. The right research isn’t worth anything unless backed up by the right actions. Over the years, I’ve corresponded with a lot of excellent analysts. Very few of them are excellent investors.

 

Now, I want to tackle a bigger quote from this excellent article. And I think it really gets to the heart of whether you are the kind of person who loses a lot of money in Weight Watchers (as I did) or makes a lot of money in Weight Watchers (as some others did):

 

“One particular trait I’ve noticed about Geoff and Quan in their recommendations for their newsletters is that they rarely like to get into very hairy situations in which the price of a stock has tanked due to some unforeseen troubles. I think it’s safe to say that they prefer to find great businesses at fair prices rather than decent or even mediocre businesses at bargain prices…”

 

That’s true.

 

I’m not a turnaround investor.

 

And this was especially true when I was picking stocks for the newsletter between 2013 and 2016. Generally, I had a list of about 10 candidates in a “pipeline” of ideas. These were usually the 10 best businesses I could come up with that were close enough to a fair price that Quan and I – as value investors – could consider buying them. In other words, we weren’t looking through lists of stocks with P/Es of 5-10 and asking which among them might be decent businesses. Instead, we were looking through a list of stocks with P/Es of 10-20 and asking which was the one we’d feel best owning for the long-run. And, often, if we loved the stock with the P/E of 15 and only liked the stock with the P/E of 11 – then we’d pick the business we liked best.

 

Now, you’re not going to find picks where we paid much more than about a normalized P/E of 15. We are still value investors.

 

But we usually picked stocks that were great businesses even when they weren’t going through a temporary, fixable problem. Buffett says the best thing to buy is a great business going through a temporary problem. Quan and I often looked for the great business part. But, we kept putting out one new issue a month – so, we really weren’t waiting for the temporary problem part. If you waited till Weight Watchers hit its problem patch, you got a much better price than we did.

 

I will take a brief tangent here to mention that Weight Watchers stock had already fallen from $80 to $32 when we picked the stock for the newsletter. So, although people who bought into this stock later would see my initial investment as being made before things went REALLY bad – Quan and I (and Mr. Market) could already see what direction results would be headed in for the next couple years. It’s just that none of us knew the stock would go from $32 to $4.

 

Having said that, it’s true I didn’t analyze Weight Watchers as a turnaround in 2013. In 2017, Munger Fan did.

 

The 3 bullet points at the top of Munger Fan’s January 2017 Seeking Alpha article are really all about seeing this stock as a great business facing a temporary, fixable problem:

 

“1) The market focused only on the negative story on the way down and no longer remembers that Weight Watchers is actually a good business.

2) There is a material possibility of capital loss and even potential bankruptcy, but I believe the probabilistic expected payoff is positive.

3) The shareholder structure is absolutely incentivized to make Weight Watchers work for other common equity holders.”

This sounds a lot like Warren Buffett’s investment in GEICO in the 1970s. He knew GEICO was still a great business. He liked the new management and thought they could turn it around. But, he saw a “material possibility of capital loss and even bankruptcy”. That’s very different from the kind of picks Quan and I made for our newsletter.

However, having said that, I don’t want to downplay just how bad the situation was at Weight Watchers when we first invested. Because the situation got worse later, people looking back on it now can imagine we bought into Weight Watchers when it was business as usual.

Nope.

I bought into Weight Watchers in the early stages of things going wrong. I knew they were going wrong and I knew each quarter’s earnings release would get worse before it got better.

Let me quote some of the headlines from my 2013 report on Weight Watchers (where remember, I was picking the stock as a buy).

 

Some Headlines from My Report

  • “Weight Watchers Has Fired its CEO, Suspended its Dividend, and Announced $150 Million in Cost Cuts”
  • “Artal Treats Weight Watchers Like a Publicly Traded Leveraged Buyout”

 

Quan and I also explained two key risks to Weight Watchers. One, the business momentum was going to be bad for a while no matter what happened. Headlines would be ugly for a time. And two, free apps (for mobile phones) were a potential problem. Now, we did not expect apps to continue to be a problem for new recruitment at Weight Watchers for as long as ended up being the case. But, we knew both these risks.

This is what we said in 2013 about free apps:

“The biggest risk of misjudging Weight Watchers is the risk of underestimating competition from free apps. The entire investment case for Weight Watchers is based on consumer psychology. The difference between an investor who is long Weight Watchers and an investor who is short Weight Watchers is probably their view of how much lasting harm they expect free apps to cause Weight Watchers. Geoff expects very little lasting harm: ‘Two of the most powerful words in marketing are: new and free. Right now, free apps are both new and free. In a couple years, they will still be free. To most people, they will no longer be new. The novelty will have worn off. So, the question is whether Weight Watchers is being harmed by the newness of these apps or the freeness of these apps. The folks who are short Weight Watchers believe it is the freeness of the apps. I don’t think free is very important to Weight Watchers’s customers. That means they don’t pose a risk to Weight Watchers’s durability.’ “

At the time we picked the stock, we also laid out the inevitability of poor earnings releases for the next few years:

“Things will get worse before they get better. With a lower subscriber base, revenue at Weight Watchers will decline for at least the next couple years. Although the company will cut $150 million in costs over the next 3 years, it will still have lower operating income in the next few years than it has had at any point in the recent past. There is no way to predict what will change this trend or when it will happen.

Unless an investor believes this pressure from free apps will be temporary it is impossible for him to come up with an owner earnings estimate and to value the stock. The only basis on which to invest in Weight Watchers is the belief that the company’s results will normalize. Many investors do not expect Weight Watchers to return to its past record.”

What’s notable to me looking back at what I wrote then is how little any of the essential analysis changed. Emotions changed. Owning the stock for over 3 years, you might get worn down by the constant barrage of bad news. But, with few exceptions, we laid out what the grim future would be for Weight Watchers over the next couple years and that’s not that different from the grim future that actually materialized. Now, in a moment, I will explain where the difference comes in. Because, I did make some projections out about 5 years to ask what the business would need to look like by then to make my investment decision a good one. I’ll re-visit that point at the end of this article.

But, what you really notice is simply two things:

  1. Some things I thought would “turn” in about 3 years instead will probably “turn” in about 5 years (that is, results will be solid in 2018 instead of 2016)
  2. And: the stock reacted far more violently than I ever expected

In late 2015, before Oprah Winfrey made her investment the stock reaction was especially extreme. I talked with some readers who asked me that since I thought I made a mistake in Weight Watchers why not sell the stock at $4, or $6, or $8 or whatever it was at in that moment.

They said basically “well, you must be sure the company won’t end up in bankruptcy or you wouldn’t be hanging on to the stock.”

Not at all.

In 2015, I thought Weight Watchers might end up in bankruptcy. But, even treating that “might” as a high probability couldn’t make the math work to justify selling the stock.

At $4 a share to $8 a share – I saw no way probabilistically speaking that the chance of bankruptcy could justify the stock’s price. In other words, if there was a chance the stock could go to zero and it was now at $16 a share, I could understand why it was at $16 a share and not $32 a share even if I thought the most likely scenario was a more normalized business situation where the stock was clearly worth $32 a share or better. After all, there might be a 50% chance of bankruptcy and a 50% chance of recovery to $32 and beyond. But, at $4 and $6 and $8 a share – I simply felt I couldn’t sell the stock, because it was cheaper on the probabilities than anything else I owned. Honestly, I couldn’t come up with odds of bankruptcy that could justify those prices. You can see why when you consider that Weight Watchers is now – and this company is still far from its prior peak – reporting $1.50 a share in earnings. Given what Weight Watchers earning power would be if it survived, a price of $4 a share didn’t make any sense unless you had advance knowledge the company was preparing to file for bankruptcy. The only way to justify a single digit stock price on something with that much earning power in its past is to have a high degree of confidence that it’s definitely going to file for bankruptcy. So, I held on to the stock even when I thought there was some chance it could go to zero. However, I sold at just $19 a share. Which – as the stock trades at $44 a share now – was clearly a mistake.

Enough about my investment.

I want to take us through the journey one of my subscribers had. This subscriber read the report on Weight Watchers. I’m going to quote his email to me in full to give you an idea of what this kind of investment journey really feels like:

 

“Hi Geoff,

 

I found WTW through (the newsletter) and bought the stock over a couple of years. I bought my first shares in December 2013 at $32.45 a share. Then I doubled my position in February 2014 at $21.71 a share.  I finally doubled my share count once again in February 2015 both at $17.40 and $11.90, making my average purchase price $19.30 a share.

 

What drove my first sell decision was that the business thesis had changed since I first bought the stock back in December 2013. I thought the company (was) a franchise type of investment. However, it turned out to be more of a turnaround. So, when Oprah bought her shares I thought it was time to (take) some chips off the table as it now was more of a turnaround, and I did not want to concentrate more than 10% of my capital in this type of high risk / high reward stock. So, I thought in November 2015 that if I sell half my position and the company fails, I would still have lost something like 1/3rd of the investment…

…I was wrong in my original thesis. I thought it to be a franchise and a long-term compounder and made a 10% position and constantly adding, while it turned out to be a turnaround. I think this was the major mistake, because if I had framed it to be a turnaround and not a franchise, I would have made the position smaller. It is not as good as a buy and hold investment as I thought it to be. So, it was a bad investment because my original thesis was wrong. The customer is fickle and demand cyclical and WTW is really providing something that people don’t really want to buy and spend money on…

 

…I continued to keep the stock, (because) I thought (of) it as more of an option than a stock in the end. If WTW was successful, I would probably make a nice gain on my remaining capital, while I would not lose all my invested capital if it went bust. So, I was more positioned for a turnaround type of investment thesis with my remaining capital. However, I got tired of the stock and decided to sell in July 2016. I still have this money in cash. What still frustrates me was that I was not (able) to wait out the thesis a full 5 years, until 2018. With a part of the remaining position I should’ve waited until the end of 2018 and to let the thesis play out for a full five years. I was wrong in my initial positioning, but I was also wrong in the way I sold. At least I was looking at it in retrospect.  I got impatient and to some degree let my emotions drive the sell decision. However, when I reanalyzed and positioned (it) like it was a turnaround, WTW still had 4 or 5 attempts (years) until the debt was due in 2020 and I thought it still could turnaround the business, but at the same time I was (skeptical) as turnarounds seldom turn. But, WTW had a history of recovering from such crises and without the debt load I would probably have been more confident in the thesis.

 

For me it raises a fundamental, but important decision: when should you revise and admit a mistake? When is your original investment thesis wrong?

Like you, my sell decisions add little value. I sold BWXT at an early stage, at $30 after the spin-off and I also sold Progressive at an early stage, at $35 a share (Geoff’s note: these are two other stocks I picked for the newsletter). The proceeds from the first was used to increase my position in Frost, while the proceeds from Progressive were used to add Prosperity to my portfolio. However, I can see that I should have kept all of them in my portfolio.

 

What I have learned from this, is that I’ve tended to turn over my portfolio faster than I really want, and that I should definitely hold my investments longer. I have to discipline myself to keep my holdings for longer. The first step is to be aware of it. The second is to act on it…

 

(Weight Watchers) also (taught) me a lesson in the challenges of investing in a cyclical business combined with a lot of leverage. One should be very careful in such instances and maybe avoid them altogether. At least one has to be mentally prepared for the volatility in the business in such cases.

 

That’s a great email. I know I wasn’t prepared for the volatility in the business and in the stock. And I wasn’t prepared for how long the wait would be with that volatility. In the report, I really laid out a five year thesis – as I pretty much always do – and yet I sold the stock after not much more than 3 years.

 

Why didn’t I wait another 2 years?

 

You get tired of sitting through all the volatility in both the business and the stock.

 

For me, there is also an added difficulty. I don’t just pick stocks for myself. I write about the stocks I pick.

 

And I get tired of answering emails about the stock. By the time I sold Weight Watchers it was not one of my biggest positions at all, and yet it accounted for probably more email questions from readers than all of my other stock picks combined. BWX Technologies is a pretty big position for me (about 25% of my portfolio right now) and yet I never get any emails about the stock. It’s a wonderful business. I think it’s got the widest moat of any company around. And yet, it bores readers. It bored them at $27 a share and bores them at $54 a share. Weight Watchers always provided entertainment value. It was something to argue about. It’s the only stock I ever wrote about where several potential subscribers specifically asked to get a different free sample than WTW (they didn’t even want to read a free issue on such a company). And it’s the only company I picked that got as long a rebuttal as this anti-WTW article from Punch Card Research.

 

It is very unpleasant to write about a volatile stock, a controversial stock, a heavily shorted stock, etc. Sometimes the best things to invest in are not the best things to write about. I don’t short stocks. And there are a few reasons for that. But, I’ll tell you the biggest reason: it’s because I write about stocks. Over the years, I’ve found Chinese companies listed in the U.S. that I believed to be frauds. Would I ever want to short them? That’s not the question. I write about everything I invest in. So, the real question is: do I want to write about frauds? Do I want to debate whether something is a legitimate business or not with a reader who is long that stock?

 

No.

 

So, I have a rule that I don’t short stocks because I’d never want to write about shorting stocks.

 

Would I have held my Weight Watchers stock till now if I hadn’t made my investment in the company public?

 

I don’t know.

 

But, I do know I’m more likely to sell a controversial stock because I have to write about what I own and talk to people about what I own.

 

The truth is that there isn’t really that much to say about Weight Watchers other than what I said in that 2013 report. I recommend everyone read that report. Because, there’s been big changes in my emotions and in the stock price and there’s been some changes with the business – most notably, Oprah’s investment – but if I was going to make a decision to buy, sell, or hold Weight Watchers today I would still base 90% of my decision on what I wrote in 2013.

 

What I’ve tried to do with this article is give you a taste of the actual experience of owning a volatile stock. What does it feel like to own a stock that goes from $37 to $4 to $44 in less than 4 years? And what mistakes do people make when a stock does that?

 

I’ll leave you with a tiny bit of actual analysis. No emotions. Just numbers.

 

This is how I ended my 2013 report on Weight Watchers:

 

“So, I look out to 2018 and ask whether Weight Watchers will be making $650 million in operating profit. And I ask whether the share count will be lower. I think it will be making $650 million (assuming a normal economic climate). And I am certain there will be fewer than 50 million shares outstanding. Unless you assume Weight Watchers will trade at a single digit P/E ratio forever, that will result in a higher stock price 3 to 5 years from now.”

This is the part where we can see I’m wrong. I was right about the P/E multiple expanding. But, Weight Watchers issued shares to Oprah. There are now more shares outstanding than there were in 2013. And there are going to be more shares outstanding at the end of 2018 than there were when I wrote that. So, each share of Weight Watchers is worth less to the extent there are now more shares. Also, I said I thought EBIT would be $650 million at the end of 2018. It’s now about $240 million and last peaked at just $550 million.

So, I was wrong on the two variables that mattered most.

In five years:

  • Weight Watchers will have at least $650 million of operating income – WRONG
  • Weight Watchers will have fewer than 50 million shares outstanding – WRONG

I appraised the stock at $63 a share back in 2013. To get as high an intrinsic value estimate as $63 on the stock now, you’d need to believe those two things I talked about (for the end of 2022 this time, not 2018). I’m not sure I do believe that. So, I’m not sure I believe Weight Watchers is worth more $63 a share.

It trades at $44 a share which is 70% of my original appraisal value. For that reason, I would not buy the stock today. To buy a stock, I generally want at least a 35% discount to an appraisal value I still believe in. Here, we have a 30% discount to an appraisal value I don’t have any confidence in.

Weight Watchers may be fairly valued.

I don’t think it’s meaningfully undervalued at today’s price.

It is, however, leveraged. So, if I’m wrong by being too pessimistic this time around – the stock will eventually zoom past $63 a share.

Of course, leverage works both ways.

The point of this article isn’t to give you a good idea of the value of Weight Watchers. The point of this article is to let you live vicariously through me and some others who invested in Weight Watchers.

“It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes.”

  • Warren Buffett

Learn from mine.

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