the Market Basket saga: taking Arthur S’s position

Market Basket is a privately held New England discount grocery chain controlled by two third-generation branches of the founding family.  One branch, owning 50.5% of MB, is led by Arthur S. and has no role–other than being on the board of directors–in the day-to-day running of the firm.  The other is led by the largest single shareholder, Arthur T.

MB recently deposed Arthur T. as CEO and replaced him with two non-family members.  Warehouse and delivery workers struck when they heard the news (with the encouragement of Arthur T., some have suggested), preventing the 71 stores from restocking and effectively hamstringing the firm.  Recently, the Arthur S. branch has agreed to sell its shares of MB to Arthur T. for $1.5 billion.

Throughout this highly public dispute, Arthur T. has been portrayed as a benevolent retail genius, creating an immensely successful business with fanatically devoted employees and extremely loyal customers.  Arthur S., on the other hand, has been seen as a money-grubbing child of privilege who wants to fund his yacht and string of polo ponies by pillaging the workers’ retirement plans.

A lot of this may be true, for all I know.  And the issues rocking MB are all pretty routine third-generation family owned company stuff (see my earlier post on MB).  But in the feel-good story line being taken by the media, one fact is being overlooked.  From what little has been in the press about MB’s profits, it doesn’t appear to be a particularly well-run company.  Arthur S. is probably right that Arthur T. isn’t a good manager.

the case for Arthur S.

Let’s say I’m a member of the Arthur S family and I hold 5% of MB’s outstanding stock.  I receive a yearly dividend of $5 million.  My genetic good fortune is significantly better even than winning the Megamillions jackpot.  So in one sense I should have no complaints.

On the other hand, my share of the assets of MB is worth about $175 million.  Therefore, my annual return on that asset value is 2.9%.  That’s about half the return on assets that Kroger achieves.  It’s also just over a third of what Wal-Mart generates, but I’m confident MB doesn’t aspire to be WMT.

I presumably also know that good supermarket locations are extremely hard to find in New England and that those MB has established over prior generations are immensely valuable.  It’s conceivable that if MB were to conceptually divide itself into two parts, a property owning one and a supermarket operating one, and have the property arm charge market rents to the stores, MB would see that the supermarket operations lose money and are only kept afloat by subsidies from the property arm.  (This situation is more common than you’d think.  It was, for example, the rationale behind the hedge fund attack on J C Penney.  That fact that inept activists botched the retail turnaround doesn’t mean the underlying strategy was incorrect.)

Even back-of-the-envelope numbers suggest something is very wrong with the way MB is being run.  Personally, my guess is that the inefficiency has little to do with employee compensation or with merchandise pricing, although the former has apparently been the focus of the AS’s discontent.  I’d bet it’s in sourcing and in how shelf space is allocated.

At the same time, Arthur T is presumably blocking my every attempt at finding stuff out and is rebuffing board suggestions that he bring in help to analyze why his returns are so low.  If MB were a publicly traded company, I could sell my shares and reinvest in a higher-return business.  I’m probably not able to do this with MB.  Even if I were, the public intra-family feuding would suggest the stock wouldn’t fetch a high price.

I have two choices, then.  I can accept the status quo, or I can try to create a consensus for the family to sell the firm.  That latter is what Arthur S. chose to do.

information: developing an edge

having better information sooner

Everyone has different education, training, life experience and interests.

Some people know a lot about cars or motorcycles or boats; some really like to shop; others enjoy eating out.  Some people are deeply involved in social media and are aware of the latest tech start-ups.  Some people have health issues that force them to learn a lot about medicines or even about trends in healthy eating.

Personally, over the years I’ve developed an expertise in retail.  Yes, I like to shop.  But retail also has the advantage that I can walk through stores or websites and be doing research.

I also like computers and electronic gadgets, which has drawn me into the technology arena.  I’ll confess I didn’t see the iPhone coming, but I certainly understood the iPod very early on.

 

Once you’re conscious of the fact that you have specialized knowledge, you can make a mindset change.  You can begin to ask yourself whether there’s a way to apply this information to the stock market.

 

My wife introduced me to Toys R Us when it was in its infancy.  My sister-in-law pointed out Chicos long before it was a Wall Street star.  When we had kids in the house I used to see what video games they and their friends played, what clothes and shoes they preferred, what music they listened to…

All of this can lead to profitable investment ideas.

 

At the moment, I think the biggest opportunity for you and me is to understand the behavior of Millennials.  Many professional investors live in a gated-community hothouse world, divorced from everyday life.  They’ll be among the last to know.

But everyone has to decide for himself what he’s willing to put research time and thought into.

concept vs. valuation

That’s the good news.  Our daily lives can be a rich source of investment concepts.

For growth stocks. that’s sometimes enough.

…but not always, and definitely not for value stocks.

To increase your chances for success, you should learn to read company financial statements.  A financial accounting course (not bookkeeping) at the local community college should do the trick.

It would also help to develop some ability to judge how much of the information you have is already factored into the current share price.  The local CC should help here, as well–although you do not want a course taught by a broker or financial planner who’s trolling for new clients.  You could also check out the PSI blog post archives.

 

 

information: finding a focus

Most professional portfolio managers start out as securities analysts.  That’s where they learn how to read and interpret financial statements, and how to make estimates of what the financials will look like in one or two years.  They also begin to learn how to decide whether the current stock price is higher or lower than would be justified by these projections.

In doing all this, they may work as assistants for a more experienced analyst.

In any event, they specialize in following only companies in a given industry, like retail, or a subsector of an industry, like department stores.

being a portfolio manager

This situation changes drastically if/when an analyst becomes a portfolio manager.  Suddenly, the rookie pm is looking at a benchmark index that contains hundreds of stocks in multiple sectors, each containing several industries.  Panic sets in, as he/she realizes that there’s no way to have an informed opinion on so many diverse companies.

The key to success as a portfolio investor, however, is not to have a superficial opinion about everything.  It’s to have a deep understanding of one or two things that will make a positive impact on your wealth.

my first encounter with real success

By far the most successful manager at the firm where I had my first portfolio management job worked in the office next to mine.  He had a very simple system:

at the beginning of each year he identified one or two companies that he thought would do relatively well, and one or two that he thought would do poorly.  He would build larger-than-index weightings in the former, using money he got by reducing his positions in the latter to below index weighting.

Then he’d monitor.

If the positions did what he expected, he’d let them ride until they’d made, say, +30% vs. the index (or -30% for the underweights).  Then he’d close them out (by returning the positions to neutral weighting) and repeat the process.  If the positions started moving in the wrong direction before they reached the goals he’d set, he’d close them immediately.

Usually, by May or June he’d amassed enough outperformance to achieved his maximum bonus.  When that happened, he’d make his portfolio look just like the index and essentially go on vacation until the next January.

how this applies to you and me

Essentially, my former colleague ran an index fund with most of his portfolio, with two added long positions plus two shorts, where he intended to make outperformance.

The first thing you and I should do is forget about the short positions.  They need a lot of attention, and they require a different mindset (I ran a very successful short-only portfolio early in my career.  It’s unusually risky and definitely not for everyone.)

We can replicate the “most” of  the portfolio with one or more index funds/ETFs.

My old friend had individual stocks in the “added” portion of the portfolio.  We can do that too, or we can expand the idea to include industry ETFs/funds–thereby outsourcing the stock selection function.  We might expand the idea further to permit small-cap, international or emerging markets ETFs/funds as “added” positions.  Or we might expand the number a bit.

The key, however, is to limit the “added” positions to ones we have an informed positive opinion about and which we are committed to thinking about and monitoring every day.

 

Tomorrow:  where to look for “added” positions.

 

 

 

information: taking the long view

the short view

Academic research claims that the best explanation for short-term stock price movements–meaning price changes over periods less than a month–is white noise.  That is, you can safely ignore them as simply random deviations from a longer-term trend.

The result isn’t quite true, as the rise of computer-based algorithmic trading, which sifts through gigantic amounts of data and pounces on the tiniest arbitrage opportunities, shows.  In addition, at least some experienced professionals, who carefully, and over long periods, observe the trading patterns of the stocks they own, develop a knack for identifying unusual price action that can have meaning.

 

But that’s not you and me.  We’re not plugged directly into stock exchange trading computers (at least, I’m not), and we don’t spend our entire day watching a Bloomberg machine with peripheral vision while we process the thousands of pages of research material fed into our inboxes each morning.

We don’t have the computer power or the ultra-low commission structure to stand a chance against algorithmic traders.  And, let’s face it, we have lives.  We’re not going to devote the time needed to be a good short-term trader, even assuming we could match wits and reflexes with a seasoned professional.

Why, then, do all the commercials for discount brokers tout the supposedly fabulous trading tools they offer clients?  …it’s because brokers make their money from trading.  Whether our net worth rises or falls makes little difference to their bottom line.

the long view

To my mind, the best strategy for you and me is to have most of our money in index funds and to spend our research time looking for a few stocks that we can get to know very well as time passes, which have a solid growth story  and which we can hold for three, or five, or ten years.  An AAPL, in other words, or an AMZN, or a GOOG, or a DIS, or a SBUX.

In fact, many of such names are what are called “retail” stocks, meaning they are discovered and supported by the yous and mes of the world and only embraced by professionals when a steadily rising stock price forces them kicking and screaming, to examine the story.

More tomorrow.

 

 

 

information asymmetry

That’s the fancy name for the situation where either you know more than the other guy or vice versa.  Think:  buying a used car, or competing in a game/sport with someone who has only half your experience and skill.

In investing, cases like the first are ones that everyone not an auto mechanics wants to  avoid.  We should, however,be spending a lot of our research time seeking out the second type.

practice vs. academic theory

One of the odder things about financial theory taught in MBA programs is the professors’ insistence–despite overwhelming evidence to the contrary–that such situations don’t exist in investing.  Officially at least, they maintain that everyone possesses the same information.

There are several odd aspects to this state of affairs:

–professional investors are happy not to rock the boat, since, to the degree that students actually believe this stuff, business schools churn out large amounts of “dumb money” to be taken advantage of,

–if all market participants have precisely the same information, how is it an ethical enterprise to charge thousands of dollars a credit to inform students that they already know everything?

–in some deep sense, professors know they live in a Copernican world despite the fact they teach Ptolemy to get a paycheck.

When I was a student at NYU, the finance faculty had a number of eminent tenured theoreticians, as well as one semi-retired portfolio manager who was an adjunct teaching for fun.  One professor proposed a contest:  faculty members would each provide $10,000 of their own money into either a portfolio managed by the theoreticians or one managed by the adjunct “practitioner.”  Over, say, a year or two that would provide a practical illustration of the superiority of theory over vulgar practice.  Unfortunately, the test never got off the ground.  No one was willing to give real money to the professors; everyone wanted to back the working portfolio manager.

More tomorrow, on making information asymmetry work for you and me.

Merrill Edge

A while ago my older son, who has a B of A bank account, told me he was going to link it to a Merrill Edge account (the discount brokerage arm of Merrill Lynch) he was going to open.

I turned up my nose.  The Merrill I knew was all about building and maintaining a suburb sales force.  Investment research and mutual fund performance always came in a distant second.

Several things have changed my mind:

1.  Most of the top-notch research houses gutted their analyst staffs during the recession, so by default Merrill has come up in the standings.

2.  The areas of the market I’m most familiar with–tech, consumer discretionary…–seem uninteresting, so I’ve got to range farther afield for new ideas.  As a result, I need more fundamental industry and stock basics.

3.  One evening, prompted by an online ad that popped up on my Google Finance page, I tried Merrill Edge.

It’s really good.

Yes, it has all the (useless) trading bells and whistles that other discount brokers have.  It also has the same lame, computer-generated “research” reports the others do.

But the huge positive feature it has is access to all Merrill’s institutional stock research.  And it’s mine  just for opening an account.  I haven’t traded enough to know whether the executions are any good, but I consider that a minor issue compared with the gold mine of information that Merrill has just opened up to me.

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