lessons from J C Penney (JCP)

preliminary 1Q13 results

In conjunction with arranging a five-year $1.75 billion loan through Goldman, JCP has filed an 8-k in which it gives preliminary information about the April 2013 quarter.

–Sales were $2.635 billion, down 16.4% year-on-year (comp store sales = -16.6%).  Looking at a two-year comparison, sales are down by 33.2% from (the pre-Ron Johnson) 1Q11.

–Cash on hand at the end of 4Q12 was $930 million.  During 1Q13, JCP borrowed an additional $850 million, by drawing half its beefed-up bank credit line.  As of May 4th, the company had cash of $821 million.  In other words, JCP has blown through the entire $850 million, plus another $109 million in three months.


1.  When things go wrong, they often have a runaway train character.  Ron Johnson joined JCP in late 2011.  Almost immediately, sales went into a tailspin.  By mid-2012 it was clear that something was desperately wrong and needed to be fixed.

But no one acts right away.  There’s always the temptation to wait just a little while longer in hopes the tide will change.

In addition, a company’s plans may be set in stone months in advance.  There are advertising campaigns, construction plans, and billions of dollars of (the wrong) merchandise in the stores–with more of the same on order.

In this case, nine months after starting to back away from the Johnson strategy, JCP is still losing cash at the rate of over $250 million a month.

2.  Cash tells the story, in a trouble company.  That’s cash flow, cash on hand and cash the company can borrow.

In the JCP case:

–cash flow is -$250 a month,

–cash on hand is $821 million, and

–borrowing power is $2.6 billion (the $1.75 billion loan arranged by Goldman plus the remaining $850 million in JCP’s bank credit line).

Assuming its banks don’t get cold feet and withdraw the credit line, JCP has total cash available of $3.4 billion.  That’s enough to sustain a cash drain at the 1Q13 rate for another 13 months.

3.  Riding coattails is a risky business.  The Financial Times website posted an article last evening titled “Tips from Wall Street gurus fail to reward faithful.”  In it, the FT looks at the performance of the hedge fund “best ideas” presented at last year’s Ira Sohn conference in New York.  In the aggregate, the tips underperformed the S&P 500.  Some, like JCP, were unbelievable clunkers.

Two factors:

–even the best equity managers are wrong 40% of the time, and

–some managers become celebrities mostly through their own aggressive marketing efforts rather than by having stellar performance.  Or they parlay a one- or two-year hot streak into an entire career.  Caveat emptor.

celebrity deathmatch: Bill Miller vs. Jon Corzine

the importance of fixing mistakes

My earliest mentor as a portfolio manager continuously pounded into my head the need to find and fix mistakes before they get out of control and destroy your performance.  This is crucial, she said, and she was right.

In her view (I’m simplifying), a good stock might get you 10 percentage points over the index return in a year.  A bad stock, on the other hand, might cost you 30 percentage points before you admit to yourself that you’ve made a mistake and sell.  Therefore, it takes three good stocks to offset the damage done by one bad one.

In other words, common sense says that you’d better spend a lot of time on the lookout for underperforming names in your portfolio.

Why the 3:1 relationship?  Why not 1:1?  I don’t know.  I do know that the bad stocks are uglier than good stocks are pretty.   As to reasons, it may be the professional investor’s disease.  Every time he buys a stock he thinks he knows more than the consensus.  That takes a huge ego.  But the same ego can get in the way of recognizing that you’re wrong.  Or it may just be that when an unfavorable event occurs, holders all rush to sell.  This activity itself depresses the stock significantly.

In any event, it’s PM 101 that you can’t fall in love with your holdings.  You have to develop some way of identifying the clunkers (everyone has them; it’s a fact of life) before they wreck your portfolio.

Miller vs. Corzine

Bill Miller and Jon Corzine are recent instances of famous Wall Street figures who forgot this lesson, with disastrous consequences.

a difference

There is a crucial difference between the two, however.

Every manager knows his asset size, his cash position and his daily inflows and outflows almost to the penny.  A professional trader working on margin knows the size of his equity in real-time and monitors it just as closely.  I find it extremely difficult to believe that an “extra” $600 million or $1.2 billion could plop down into accounts you’re managing without your noticing it.  That’s doubly true if the money is needed to stave off a ruinous margin call.  You’d have to know, in my opinion, and would immediately want to understand where it came from.


What do the two managers have in common, other than their inglorious ends?

Both were very successful for an extended time within the long period of interest rate declines in the US that occurred between 1982 and, say, 2005.  That period, which is over now, taught managers to expect that even extreme risk-taking would eventually be bailed out by lower interest rates.  Neither man seems to me to have understood that this strategy no longer works.

Both appear to have forgotten to play defense.

My guess is that Mr. Miller regarded the recent financial crisis as a replay of the savings-and-loan meltdown that he successfully navigated in the early 1980s.  So he had reason to believe that he had an edge over other, less experienced stock market investors.  Mr. Corzine, on the other hand, strikes me as being more like a professional athlete who returns to the field after a decade working in an office and assumes that he can perform at the major league level from day one.  He seems to me not to have noticed that the other guys were faster, stronger and had instincts honed by never having fallen out of game shape.

In a lot of ways, professional investors are like kids playing video games.  Firms that employ them typically recognize this and install checks and balances that either force them to consider the business consequences of their actions or set portfolio parameters beyond which they are not permitted to go.  Both Miller and
Corzine seem to me to have been so deeply entwined in the management of their firms, however, that the firm’s risk controls were overridden.

Both are cautionary tales for investment professionals.

portfolio checkup (II)

measuring performance

As I wrote yesterday, one reason for doing a portfolio checkup is to give yourself a report card/planning tool for assessing your portfolio performance and making appropriate adjustments.

getting to know yourself

A second reason is to, as time goes by, analyze yourself–the strengths and weaknesses, blind spots, or maybe just plain quirks–that influence your investment performance in recurring fashion.

For example:

1.  On the most basic level, consider whether you should involve yourself in active management at all.  Are you putting in the time and effort to follow the stocks/funds you own?  Do you have a well thought out reason for having purchased them in the first place?  Are they, either all individually or in the aggregate, adding to performance?  …or are you losing money on almost everything?

If you fit this laast description, maybe you should stock with a paper portfolio for a while and keep your real money in index products.

2.  A variation on #1–do you have more stocks than you have time to follow?  From a making money perspective, it’s better to do a few things well than a lot of things badly.

3.  Do you spend all your time on your strong-performing stocks and forget about the weak ones?

This is the normal human tendency, but it’s one to overcome as fast as you can.  If anything, your time allocation should be the opposite.

If you fit this description, you may just have too many stocks.  Or maybe you can’t bring yourself to sell a stock at a loss–which is the most common mistake that even the most seasoned investors make, in my opinion.

In either case, this is a behavior pattern to recognize, and a situation to deal with immediately.

4.  Are there types of stocks you typically do well with or do badly with?

This is a very broad question.  In my career, for instance, I’ve found I’ve done the best with stocks in consumer, technology, leisure/entertainment and real estate industries.  I’ve done the worst with financials and medical products/devices.

I can still remember clearly information sources from twenty-odd years ago that provided detailed and highly persuasive (to me, anyway) research that invariably turned out to be wrong.

I know I’m out of my depth in markets like Indonesia or Korea.

In cases like this, it may be interesting to know why you’re successful or unsuccessful in certain areas–but it’s not necessary.   The more important thing is to realise that your experience is what it is.  Just stop doing the things that always turn out badly!!  (For most people, this is much easier to write than to do.)

5.  Do you sell too soon?  …or do you hold on too long?

This, by itself, is useful to know.  In my experience, there are usually psychological cues that you either respond to or ignore that produce this behavior–or there are trading signs, either in volume or price action, that you use that produce the same result. By looking for and paying attention to them, you may be able to improve this aspect of your game.

6.  Do you buy badly?

The cliché (and to steal a line from Hegel, things have to be very true to get to be clichés) is that value investing is all about buying well; growth investing is all about selling well.  To my mind, buying badly means acquiring the stock at a price where there’s little potential for profit.  For growth stocks, this typically means buying just as growth begins to decelerate; for value stocks, this means buying assets worth $1 for $.80 each instead of at $.30-$.40.  For all stocks, this point is usually when the stock is the most popular.

7.  Where do you get your ideas?  They can come from anywhere.  Some sources–maybe your own experience as a consumer–are great; others, like the brokerage house in #4 above, may be awful all the time. Once you’re aware of patterns, you can pay closer attention to the good sources and eliminate the bad ones.

Be careful of TV and radio shows.  Investors who are guests on stock market shows always talk about their largest positions.  They never (for legal reasons) talk about stocks they’re thinking of buying or are in the process of acquiring.  Sometimes, although this is unethical conduct, they talk up stocks they are warming up to sell.  The commentators on these shows are by and large professional news presenters, not professional investors.



portfolio checkup

A friend who’s studying in the Netherlands and just starting out as an investor emailed me a question about what a portfolio checkup/cleanup is supposed to do.  I thought I’d reply in this post and in tomorrow’s.

two objectives

Basically, you analyze your portfolio carefully and at regular intervals to do two things:

–so you know for sure how your portfolio plan is working and what quantify which stocks or ideas are adding to or subtracting from your performance, and

–so you gradually learn about your investing personality.  By this I mean what things you typically do well and which ones you aren’t so good at.  You want this information, as painful as it may sometimes be to find out, so that you can emphasize the former and minimize the latter.  After all, the main goal is to earn/save money–not to massage your ego.

#1  figuring out performance

There’s a purely mechanical aspect to this.  You have a benchmark like the S&P 500, by which you judge your performance (you could achieve this return by buying an index fund.  You should only spend time and effort to select individual stocks or focused ETFs/mutual funds if you expect a return higher than the index fund will give you).

Over the past three months, the S&P 500 is down about 7.5% (ouch!).  Over the past month, it’s up about 9%.

Your first task is to calculate how your portfolio has performed vs the S&P over the interval you’re studying–both as a whole and each individual issue.  (For what it’s worth, after a long period of doing well, my stocks have been clobbered over the past month.)

what to do with this data, once it’s collected

a.  look for outliers, especially big losers.  Everyone has losers.  Everyone, even the most seasoned professional, also has an almost infinite capacity for denial.  My first mentor as a portfolio manager used to say that it took three winners to offset the damage that one big loser can do if it’s left to run amok and not caught early. So finding losers and eliminating them is important.

b.  ask if your plan is working.  This presupposes you have a plan.  A checkup may well bring out that you’re not bringing your intelligence, knowledge and experience to the party but are, so to speak, mailing it in and hoping that’s good enough.  (We all find out quickly that it isn’t.  Although individual market participants may not be the sharpest pencils, the collective entity is extremely acute.)

For example, in general my plan is:

–world economies are still expanding, although slowly.  So I’m still positioned for an up market.  The EU has me worried.  I’m thinking about shading toward larger, stodgy sort-of-growth stocks as a defensive measure but haven’t done anything much yet.

–there will continue to be a sharp separation between haves (mostly meaning having a job) and the have-nots (the 10% or so long-term unemployed in the US).  I want to own stocks that cater to the former and want to avoid stocks whose market is the latter.

–Asian, especially Greater China, exposure is a good thing, because that’s where most of the world’s economic energy is centered

–I think the continuing proliferation of smartphones, tablets and e-readers plus the rapid development of cloud computing mean there’s money to be made in at least some tech stocks.

For me, the relevant question is how this is working out for me overall.  The answer is:  great, until about a month ago.

A second aspect of figuring out performance is to look, stock by stock, at plan vs. performance.  Reading any of my posts about TIF will get you my stock-specific plan since I bought the security about a year ago.  Again, until about a month ago, things were working well  …since then, not so much.

c.  acting on this information

Even in the best of times, the stock market is always a process of two steps forward, one step back.  Also, all stocks, even the long-term winners, have periods of underperformance.  There’s a real experience-and temperament-based art to deciding how to react to the data that show your stocks are underperforming.

In my case, I’m thinking so far that this is a temporary adjustment phase.  But I’ve also got to at least begin to consider how I’d rearrange my holdings if the underperformance persisted.  This thought process–and the possible move to action–is partly a question of risk tolerance, partly of conviction in the correctness of my analysis of individual stocks, and partly a judgment, based on experience, of what is a normal trading pattern vs. a fundamental change in market direction.

More tomorrow.

analyzing your portfolio performance over the past three months

measuring performance

I’ve written before about how important it is for us as stock market investors to calculate and analyze the performance of our portfolios on a regular basis.

There are two related reasons for doing this:

1.  We want to identify what ideas/stocks are working for us in the portfolio and which ones aren’t.  Based on this, we decide where to take profits and where to stop the bleeding.

2.  We also want to learn about ourselves, and our strengths and weaknesses in decision-making.  This isn’t like training for the Olympics.  We don’t need to be perfect at everything.  But we want to at least be able to identify situations where we continually shoot ourselves in the foot–and just not do that anymore.

doing it now

On July 7th, the S&P 500 closed at 1353.  On October 3rd, it closed at 1099, for a decline of 18.8%.  On an intraday basis, from 7/7-10/4 the fall was 21%.

The markets appear to be stabilizing now, as politicians in Europe make noises about finally addressing the EU’s Greece/banking crisis.  It’s too soon to say for sure that the worst is over (although I suspect it is).  But whatever the case may be, it’s important to look at your portfolio after a decline of this magnitude and ask yourself how you fared.

how to do it

In all likelihood, you don’t have data from your brokerage account that tells you either what your portfolio as a whole, or any individual security in it, was worth on the beginning and end dates.  So the easiest way to proceed is to use a Google chart to compare the performance of the S&P 500 (or whatever benchmark you measure your portfolio against) with each of the stocks/mutual funds/ETFs you own.  You can find more details toward the end of my post on “method to the madness” a few days ago.

what to look for

1.  One question is whether you’ve outperformed or underperformed the benchmark. But that’s just the start.

2.  Growth investors outperform in up markets and underperform when the market is declining.  Value investors, who have a more defensive bent, do the opposite.  So a second question is whether your portfolio has performed in line with your design.

3.  Is your design really what you wanted?  Is it appropriate for your financial circumstances, or is it too risky–or not risky enough (not the usual problem, but possible)?

4.  What were your strongest and weakest stocks?

5.  Is there a pattern to either the good ideas or the bad ones?  Be careful here.  Over this period, utilities stocks would have been stellar names, capital goods or materials stocks were probably at the bottom of the pile.  That’s not what I mean. You’re looking for behavioral patterns that lead you astray so that you can change them.

Do the weak stock ideas come from names you hear on CNBC?  Are the good names ones where you know the financials backwards and forwards and the bad ones those you know less well?  Are the horrible stocks tips from cousin Fred the broker?  Are the large positions winners and the small positions losers–or the reverse (which would be a more serious issue)?

Some fixes are easy:  turn off the TV; do your homework; don’t act on Fred’s advice; don’t bother with the small positions (or weight each position equally if the small ones are good but the big ones are killing you).

6.  How are your positions doing in the rebound?  Stocks rarely outperform in both up and down markets.  Great if you have one or more of these.  In contrast, in my experience it’s a big red flag if a stock underperforms on the way down and remains an underperformer in a market bounce.  Any like these are ones that need your immediate attention.

7.  Are the reasons you bought each security still valid?

two other thoughts

–Looking at your portfolio decisions with a critical eye is something you need to do regularly.  One time won’t be enough to detect behavior patterns.  But you’ve got to start somewhere.  My experience is that even professionals make mistakes that would be easy to correct–like “don’t listen to Fred”–except that they aren’t aware they’re making them.

–For an analysis like this, don’t use year-to-date numbers.  What you want to see is how your stocks have done in the downturn.  Otherwise, if you have had significant under- or outperformance earlier in the year, that performance difference will just muddy the waters.  An example:

Suppose you have a security/portfolio that was 20 percentage points ahead of the S&P through July 7th.  That would mean you had a gain of 27.7%.  On October 3th, your holdings are down 2.7%, which is ten percentage points better than the market.  How much performance have you lost during the downturn?

The answer isn’t ten percentage points.  It’s five!  During the period we’re considering, the S&P 500 fell by 18.8%.  Your investment went from 127.7 to 97.3.  That’s a fall of 23.8%.  The difference between the fall in the index and in the investment is five percentage points.  The rest of the year-to-date loss comes from the fact that the investment has lost its 18.8% from a starting point that already incorporates a large year-to-date gain.  The gain portion also suffers a loss.