Now, I had listened to my kids many times for ideas about where they liked to shop: Hollister, which is how I caught a 40 percent move in Hollister’s parent, ANF Abecrombie & Fitch; Google, which was easy because all the teachers had written at the top of their homework assignments “No Googling.” But this time I realized I had something very big, an investment thesis that no one seemed to have: Apple as fashion accessory.
I bought the stock at $26 with a goal of owning it for as long as the fundamentals checked out and until others in the research grasped the significance of the Apple brand. But when the stock moved up a quick 5 points, I figured, okay, so much for the investment thesis. Let’s take the trading gain.
Everyone knows the Apple story. It went up fivefold, in part because of the recognition not just by analysts but by competitors, particularly Microsoft with its disastrous Zune competitor, that Apple is fashionable and that fashion means more than just utility; it means you can charge more and you can sell more. Each time I read a new analyst’s report that grasped the concept, I kicked myself. I had a fabulous investment thesis, from my kids no less, and turned it into a trade.
If you know something’s going to be an investment, you have to be willing to sacrifice the quick gains.
By the way, the takeaway is not that your kids are always right. Not long after the iPod brainstorm, I brought home a pair of Crocs because the company was about to go public. My younger daughter despised them. She said they were the ugliest things she had ever seen. The stock then quintupled.
But my elder daughter got behind Under Armour shirts as both a fashion statement and an athletic one. She insists on wearing Under Armour under her lacrosse and field hockey goalie pads. Kids are terrific sources of ideas, but you still have to do the homework. Elder daughter, one for one; younger, one for two.
8. Trust your instincts, not your friends…There was a terrific water company where I grew up outside of Philadelphia, Suburban Water, and it had a great reputation for pristine water and for management. A fabulous guy, Nick Debenedictis, ran the company. He was someone I had met several times and someone I considered to be a friend of both Kudlow & Cramer, my old show, and Mad Money.
Suburban Water, which became Aqua America, had been a consistent grower, but one thing disturbed me: it kept growing via acquisitions but showed very little core organic growth. Also, every time it bought a company, the target company’s insiders would sell Aqua’s stock heavily. Nick convinced me that the company was not masking a lack of growth and the insiders just desired some liquidity. So I bought the stock heavily in the $25 and $26 range.
For seven months I held on to it. During that time it kept making deals and the insiders kept selling. And then it had a shortfall. Why? Not enough organic growth. My instincts had been right, but I had let a friend sway me. As I say every night at the beginning of Mad Money, the show’s not about making friends, it’s about making money. If only I had listened to myself instead of Aqua America’s management. It’s too bad too: Nick is a great guy! But this water company ran out of steam.
And of course, beware of any company that needs to grow endlessly through acquisitions. That’s a sign that the core business is slowing, regardless of what management says. Never let someone talk you out of what you know to be right in companies where you don’t know the management.
9. Don’t let short-term bad news scare you out of a good long-term stock. I had always favored the business model of Aramark, a food service company that started in Philadelphia. I was a vendor for years at the now-demolished Veterans Stadium in Philadelphia—I must be old, because I was at the first game played there! And I could see how much a well-run vending company could make.
Aramark had consistent earnings from managing sporting events and stadiums and had branched out to providing food for corporate lunchrooms. It operated like a Swiss watch and it generated cash as surely as the U.S. Mint. That kind of consistent cash flow always catches the eye of the private equity folks, who know that companies like Aramark don’t need to be public and can make a lot more money privately because of their regular earnings streams. So I bought four thousand shares over a matter of about a month, at $26.
Wouldn’t you know it, but that summer I learned there would be a National Hockey League lockout. Aramark has contracts with a lot of arenas where the NHL plays. I decided that there was no reason to own Aramark if its consistent earnings were going to be jeopardized by the lockout. So I sold it for a dollar-a-share loss. Sure enough, there was a lockout, and Aramark announced that the lockout would cost it a couple of pennies a share. I felt vindicated—until a few months later, when it went private for about $10 more than I had sold it for. I had let short-term bad news knock me out of long-term gains.
10. If you buy a position to fill a need in a portfolio, don’t jettison it because it’s not working. I like owning a gold stock as a hedge against the world’s craziness and instability. I often tell people who call in to my show that if I have a ten-position portfolio—as I say in Real Money, if you have the time and inclination to spend an hour on every position per week, you must have a minimum of five stocks to be diversified—there is room for a gold stock. I feel the same way about my twenty-something positions in my charitable trust. When I started ActionAlertsPlus.com in 2002, I decided to buy Barrick Gold as the hedge in my portfolio. As other stocks went up, Barrick languished and started going down, so I sold it even though I’d bought it as a hedge. Sure enough, as the Middle East turmoil bled on and oil soared, Barrick moved up substantially, doubling over the next three years from where I had sold it. Barrick would have been the perfect hedge against oil-spike inflation, which is why I bought it in the first place! When the inflation scourge flared, I had little to protect myself in my stock portfolio.
If you buy a stock because you want it to counterbalance a portfolio or hedge out risk, don’t sell it because it isn’t working. That stock’s your insurance, and just because lightning hasn’t struck lately doesn’t mean you shouldn’t have insurance. Don’t boot it out because it’s not acting well compared to the rest of your portfolio; it’s not supposed to!
I made a similar mistake a year later, this time buying something for a dividend because I wanted income. I bought BP, which yielded 4 percent, and then when I made 7 points on the stock, I decided that I no longer needed it and wanted the gain. I didn’t buy it for that reason, though; the gain was just an unexpected windfall. I had picked BP because it raised its dividend consistently each year, but did I stick around for the increase? Did I really want an income producer, as I said when I bought it? No, I was satisfied, wrongly, with the capital gain, which was simply a delicious piece of icing on the dividend cake—not reason enough to trade in the cake, though. Sure enough, the stock rallied another 15 points in the year and a half after I sold it, and it still yields 4 percent because of its bountiful dividend policy. (The dividend grew as the stock price grew, which kept the yield steady at 4 percent.) If you own a stock for hedging or for dividends, don’t contrive reasons to sell it, and don’t just take the gain. You’ve got valid reasons to hold it through thick and thin, unless the gold company becomes something else or the oil company slashes the dividend. Sometimes when you choose to preserve capital you also make money, but if you are buying security, don’t sell a stock because you’ve made a quick buck. Remember why you buy things and the reasoning you went in with will not betray you.
11. Uninformed low-dollar-amount speculation can wipe you out. Those of you who have followed my writings over the years, and now you new folks, should understand the value of speculation. It makes you more interested, keeps you in the game, and gives you an incentive to pay attention, all of which are vital if you’re going to manage your own portfolio. When I set up my charitable trust, I was true to my word, deciding to put on a long-term, low-dollar-mount speculation that could turn into something huge.
I had always been enamored of the cable television model. At the time I believed that once you had cable,
you regarded it as a utility and would no sooner abandon it than give up your electricity. So I picked Charter, a debt-laden cable company that sold at $4, for my speculation. Given that I’m running $3 million and given my desire always to be diversified, I decided to make this speculation a little more than 7 percent of my portfolio, the outer limits of what I have deemed safe because it won’t tilt the portfolio down in a meaningful way.
In a series of very public presentations, Charter outlined its plans to go from a company with too much debt with a high interest rate to a company with modest debt and a good footprint in some growth areas around the country. Charter had about $18 billion in debt at the time and was struggling to refinance at lower rates—just as you would try to refinance a 10 percent mortgage down to 6 percent.
I bought the stock in November 2003 with the presumption that I would give management twelve to eighteen months to sell off properties and fix the balance sheet. I buy stocks for that period of time because that’s about how long it should take for an idea, a really solid idea, to generate a great return. Anything longer than that, particularly in a stock that has failed to appreciate or actually goes down, is too long and you simply have to give yourself a failing grade. I waited for quarter after quarter for Charter to make good on its promises to sell assets and shore up its balance sheet. But the company did nothing except bleed. One quarter, two quarters, three quarters, and all that happened was the stock went down.
Frustrated, I went to see Charter’s management at a presentation and demanded that they fulfill their obligations to shareholders. (Although I don’t expect you to do this as a home gamer, it is possible to go to a company’s annual meeting or any public presentation. As long as you are a shareholder, the company has to let you in. It’s not like the old days, when you had to be a big institution to attend these meetings.) Management counseled patience. In the meantime the stock continued to drop. After the fourth quarter the stock dropped to the low $2s. I refused to give up. I dug in my heels and told readers that I believed the company was finally waking up to its destruction of the shareholder base. But they just postponed again.
After the sixth quarter, the stock collapsed to $1 and change. On a strong market rally the stock managed to go back to the $2s, but I had had enough. The company simply could not grow its subscriber base. Plus, given its lack of capital, it could not keep pace with all the innovations cable companies were introducing: high-definition, pay-per-view, and triple-play phone service. It either had some of these but could not advertise heavily because it was so cash strapped, or it didn’t have enough money to develop them in other areas and was beginning to get hurt by satellite and by more aggressive telephone companies. I was beside myself.
There has to be an end point to all investments when they don’t work, when the thesis doesn’t play out, and after eighteen months I gave up and took a $130,000 loss, the biggest loss I have ever taken in my charitable trust. The lessons were clear: (1) Just because it’s a low dollar amount doesn’t mean you can’t lose a fortune. (2) If you speculate, do not speculate with a company with a terrible balance sheet; it may never come back. (3) When management makes promises and fails to deliver over an eighteen-month period, you have to accept defeat. (4) Indebted firms cannot compete with those that don’t have as much debt, making them far more problematic stocks than those that are without much debt. (5) If you think you’ll get bailed out, perhaps by a takeover because you think that the stock’s price—the amount of dollars it costs to buy a share, which is meaningless, not the price-to-earnings multiple—is small, forget it. Other companies see the same thing you do. (6) If the stock had a higher dollar amount—if it had done a reverse split—I would never have been attracted to it. What drew me to it was its under-$5-a-share status. (7) It is irrelevant where a company came from to get to $5 other than to suggest that it didn’t get there because it is doing well. At one point Charter was a high-flying $25 stock. It didn’t matter that it had once been there. That was totally irrelevant. Good stocks don’t travel to the single digits. I was foolish to be attracted to it just because it “looked” cheap.
All of these horrible investing mistakes give you some fabulous guidelines for the kinds of stock to avoid if you speculate. There are tons of companies out there that simply don’t have any ability to fix themselves. While I am all in favor of speculation, it must be informed speculation with benchmarks and targets; otherwise you’ll lose far more than you ever expected. When you ask yourself, “How low can it go?” think of this Charter situation. A stock can go pretty far down, enough to lose you huge money.
By the way, Charter never came back. It’s about where I sold it, give or take a couple of dimes. Pathetic company, pathetic speculation.
12. Love the product, don’t love the stock. You may be very late to the cycle and miss the upside. When I was doing my radio show, I had to do it remotely. Many radio hosts like to have someone on staff in their ear telling them the name of the caller and where he or she is from. I didn’t want to be distracted by that.
One day, after a year of trying to deal with the incessant chatter in my ear while giving people good advice, I protested that I could not do a good job unless there was another way. My telephone board operator went to his top-notch tech guys and came back with what they said was a brand-new solution: “Go To My P.C.” from an outfit called Citrix. I was able to download the program and on the other end the telephone board operator did the same thing. This software allowed me to access remotely the names of the callers.
It was miraculous. I couldn’t believe such a product existed. I researched all the public filings on the company. It seemed very strong, and the product I liked so much was one of Citrix’s most important contributors to the bottom line. So I leaped at it at $43 in the spring of 2006, expecting that others in the industry, and outside too, who also needed remote software that allowed them to hold meetings and all see the same thing at once, would snap up the product.
And you know what happened? The company reported its quarter and it showed a distinct slowing in this product line. Everyone who needed “Go To My P.C.” seemed to have ordered it. Contrary to what I had thought to be the case, or my tech guys had thought to be the case, I was late to the product cycle. (You can’t rely even on the tech experts in the field, because they may not know either.) I was on the tail end of the new customer base.
There was nothing I could do. The product had peaked, and after a tech product peaks it is all downhill. I had to sell the stock 10 points lower, as there was no reason to hang on. It subsequently went even lower before it was able to stabilize, but it never recovered to where I had bought it despite a huge rally in the market. I liked the product so much that I bought the company, not realizing that as great as the product was, I was coming in well after the product had been adopted.
The moral? You may think you are early in the development of something, but you may be late, much later than you think. Just because you discovered something doesn’t mean it hasn’t been discovered many times over already. Could I have recognized how late I was in the product’s cycle? I think that I could have simply by asking how long the product had been on the market. At the time I bought, it was about three years. That’s late in any tech cycle, whether it be the Pentium chip or the Motorola Razr. Without constant innovation in tech you will be passed by another company doing something better, or you will have a saturated customer base and only a few rare radio hosts will be left to sell to.
13. Never buy the best house in a bad neighborhood. About midway through my radio show’s history I wanted to get picked up by Cumulus Media, the second-largest radio company in the country. So I called its terrific CEO, Lew Dickey, and beseeched him for a meeting. He obliged and came to the offices of TheStreet.com.
Dickey was energetic, charismatic, and enthusiastic, so much so that he could not contain himself about the coming renaissance of radio. He was talking about all the new formats and how radio was going to win back customers be
cause, in the end, it was the customers’ favorite medium when driving in the car. It was the spring of 2004 and radio had been in the dumps since the collapse of the dot com era, when many companies had relied on radio to spur business. I said that radio seemed to be a dying business. He insisted that it wasn’t, but more important, his business was certainly not dying. His business was generating huge net cash flow—what’s left in actual cash when you deduct all the costs of doing business. He gave me no non-public information—remember that great equalizer between the pros and the amateurs I wrote about in the last chapter—but it did seem like a terrific story, even if the other radio companies were being shunned by investors.
I bought the stock at $19 over a series of months and readied myself for the renaissance. Meanwhile, Sirius and XM had different views and the auto companies began including them in new models. When I got my new car, satellite radio came standard. And my kids used the electronic jack in the car for the iPod. Commercial radio responded by running fewer commercials but charging higher rates, which they could not sustain.
Cumulus did better than the average radio company, but its stock performed just like the others. Six months later—that’s how dynamic business can be—the stock was down 25 percent, part of an overall exodus from all radio companies. I had bought the best house in a bad neighborhood.
I realized the error of my ways—which was, of course, against my conviction to begin with—and took the big loss. The stock proceeded to get more than cut in half over the next two years and then, adding insult to injury, Dickey took the company private in 2007 at a little more than half of what I paid for it in 2004. I say this added insult to injury because had I held on to it as a classic long-term buy-and-hold investor, I wouldn’t even have had a chance to get back to even. If the renaissance ever occurs, I sure won’t be a part of it.
Jim Cramer's Stay Mad for Life Page 19