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Durable Competitive Advantage – Why it matters

It sounds nice but what does it mean and as an investor why do I care about it? Durable competitive advantage is sometimes referred to as a “business moat”. In its simplest term, it means the scale of a business in its field vs it peers. That is its “competitive advantage”. But, what makes it durable? What make an advantage durable is the cost and time it would take a current or potential competitor to grow large enough it this area (high barrier of entry) to adversely impact our business. A high level of durability allows us with a greater degree of accuracy to predict future earnings and thereby arrive at a price we are willing to purchase a piece of the business (share of stock). Now, how do we recognize those businesses that have this (or don’t) and how we look for it. Strict adherence to the “durable” portion of the phrase enables us to do one thing before we even begin to look at possible stocks to invest in: eliminate whole sectors of possible investment. This makes our investing easier by shrinking the field of candidates and reduces the chances of us making the mistake of investing our money in a good company in a lousy business.

Some examples of sectors that lack the “durable” portion:

Airlines: Investing history is littered with airline bankruptcies. Once high fliers fall victim to either high or low jet fuel prices or a recession and go under. After 9/11 were it not for the US Gov’t bailout of the airlines, most of them would have failed despite only being out of business for less than a week. High union costs, fickle customers and volatile fuel prices make any accurate assumption of future profits by investors impossible. Why would you buy into a company in which you have no idea of its future profitability? Southwest Airlines is a great company and the best managed of all the airlines but investing in it is akin to having the best lounge chair on the Titanic, eventually you’ll be sorry.

Tech: We have to be careful here and not throw the baby out with the bathwater. Not all tech qualifies here but let’s look at it generally and you will have to decide on a case by case basis. Warren Buffett of Berkshire Hathaway (BRKA) said it best about tech investing. I will paraphrase “I cannot invest in something that two teenagers with a pc in a garage can destroy”. What? Simple, Micheal Dell started building pc’s in his Texas dorm room, Bill Gates started Microsoft in his garage, Ebay was launched in a weekend from a living room after a labor day conversation and Google was a research project by two Stanford University students. All these businesses toppled industry leaders at the time and Google is in the process of doing it to several now. How can you be confident about an investment that an 18 year old writing code in his family room before he takes out the trash could make obsolete? This industry must constantly reinvent itself almost yearly in order to survive. The pace of the necessity of this change is accelerating every year. Look at the ipod, its success has exploded the last 3 years and in 6 months the iphone comes out. Having an ipod and a phone and having to carry both around will be a thing of the past. Competitors will flood the market with similar products and the stand alone ipod will be history. It will be relegated to the “remember when” conversations. This is how fast things change in tech and all these companies make missteps along the way and when they do, investors pay the price, heavily. Remember, since 2000 when investors thought these companies reinvented the rules of investing, Microsoft (MSFT), Dell (DELL), Amazon (AMZN), Yahoo (YHOO) and other are all still down over 40%. When is the last time you did not buy a bag of M&M’s because they “were so yesterday”, searched for the “newest version of Arm & Hammer baking soda” or would not be caught dead eating a Hershey’s candy bar? Me either..

You have to wade through the tech field carefully (I personally avoid it) and if you do decide to jump in, please do not do what most tech investors do, overpay for your shares (see yesterday’s Google post).

Auto Industry: See airlines

Pharmaceuticals: Decades ago these were great investments. However, the advent of generic drugs has turned this into a simple commodity business. They used to enjoy the financial fruits of new drugs for decades, now the exclusive locks up are shorter and increased competition means competitors have similar products in the market almost simultaneously with the generics undercutting profits. This industry is under attack by govt’s and now in the courts by users of their products. The economics of their industry have permanently changed for the worse and it should be avoided as they are spending more and more money to develop drugs with smaller profits potential. Bad equation.

So, now we have a brief idea of what to avoid it would be nice if I gave you some ideas of companies that have a competitive advantage that IS durable.

McDonald’s (MCD)- The turn of the century was hard on the golden arches. They had the perfect storm of bad events and the stock was punished over the next two years from almost $50 down as low as $14. Some of the mistakes were theirs and others were from events beyond their control. The turn of the century began with a heightened interest by consumers of what they put into their bodies. McDonald’s was slow to recognize this and their sales began to suffer. Then came mad cow. The whole fast food industry suffered as consumers began to look for options other than meat products to eat and McDonald’s was once again slow to react. Then the Jack In The Box chain in the pacific northwest began serving ecoli burgers and killed several people. These events lead people to fear the drive thru window. But, what was really wrong with McDonald’s that a menu fixin‘ wouldn’t cure? Nothing! Because of the durable competitive advantage it held over the rest of the industry and the value the McDonald’s brand held worldwide, after some menu tampering McDonald’s was once again off to the races. It has a worldwide distribution system second to none. It has since survived the premature death of 2 CEO’s and share are up 214% from their lows. Recent proof of McDonald’s advantage has been the introduction of coffee at its locations (good coffee I should say). It has been a huge success and chains like Dunkin‘ Donuts and Tim Horton’s have noticed sales declines were McDonald’s competes. At is low McDonald’s was a value investors dream…

John Deere (DE) / Caterpillar (CAT): If you are either farming or in construction your search for equipment most likely begins and ends at either of these companies. Both basically invented the industries in which they operate and by far are the world leaders in them to this day. Both stocks are up over 125% since 2000.

Walt Disney (DIS): When you think of your childhood or amusement parks does anything other than Disney come to mind? After stumbling at the turn of the century the House of Mouse has righted its ship and shares are back on the march. If you are my age and your folks had bought you Disney shares when you were born you would be sitting on a 5000% gain.

Hershey (HSY): The Hershey Company markets such well-known brands as Hershey’s, Reese’s, Hershey’s Kisses, Kit Kat, Almond Joy, Mounds, Jolly Rancher, Twizzlers, Ice Breakers, and Mauna Loa, as well as innovative new products such as Take 5 candy bar and Hershey’s Cookies and is the largest chocolate manufacturer in N. America.

Coke (KO)/ Pepsi (PEP): The two dominant worldwide soft drink makers. If you really think about it, they are really the only two of any significance. Their products are known worldwide and both stocks have produced. Had your folks bought you share in either when you were born in the early 70’s you would be sitting on in excess of 3000% gains.

All of these companies have rewarded loyal shareholders with great gains. The important thing to recognize is all have had their problems and because of their durable competitive advantages, have not only weathered the storms but emerged stronger companies.

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TIME FRAME VS. RISK – The Inverse Relationahip

All investments have risk. No matter how safe they look and feel, there are risks involved. Let me get that out of the way first. You can never eliminate the risk you assume when you plop down your money on an investment. The question then becomes, how do we minimize that risk? There are many alleged ways, do exhaustive research, only buy bonds or CD’s, avoid tech stocks, etc, etc, etc. Many of these “risk avoidance” options also come with the “return avoidance” result. Yes, you can almost totally eliminate all risk by buying a cd at your local bank but in today’s low interest rate environment you are barely making a return in excess of the inflation that is eating away at those dollars. Also, you have now locked those funds away and can only get YOUR money back should you need it by paying the bank a hefty penalty. There is risk.

This discussion will focus on stocks. While the reasoning I will illustrate does apply to most investments, the discussion will focus on the effect on common stocks and their investors. Let’s look a two charts and try to decide which looks like the better investment:



A quick look would have us saying chart #1 is the far superior investment. Here is the thing though, both charts are of Sears Holdings (SHLD). Chart #1 is SHLD since its inception and chart #2 is its chart for the past 3 months. Same investment and depending on your time frame, two very different results.

When you have a very short time frame, your attention to every minutia of information that may effect the stock is mandatory. Let’s use the 3 month chart above. This investor bought SHLD in October hoping to capitalize on the typical holiday bounce retailers seem to enjoy. What “risks” are there to his investment? Off the top of my head I can think of same store sales at Kmart fall, same store sales at Sears fall, warm weather keeps people out of the mall, snow keeps them from getting there, an “analyst” downgrades the stock out of the blue, the Fed decides to raise interest rates, Iran cuts off oil and it spikes to $80 a barrel and the whole market falls while investors sort it out, Lampert loses money that quarter in his investments (it is bound to happen) or a fire at the Land’s End factory destroys the winter line and quarterly results are adversely effected etc, etc. There are dozens more but those are just a few I came up with without really thinking about it. All of these have no long term effect on SHLD but in the short term would be negatives to the price of the stock (not the value of the company). What should he do? If he reads news articles on SHLD he becomes more confused, one says buy, on says sell and a third chastises him for even buying it in the first place! This investor has probably become frustrated and sold for either a loss or no gain.

Now, investor #2 has held the stock for 2 years now. He sat back and watched during the summer and fall of 2005 when the stock fell from $160 to $120. As he looked at the company he could see no fundamental reason for the dip. Nothing had changed with SHLD and the reasons he bought it were still valid. This being said he decided people were wrong for selling and bought more during this drop (many smart Berkshire Hathaway (BRKA) shareholders did the same during the tech bubble in the late 90’s and have been richly rewarded). The stock has since rebounded and broke through the $160 level up to the near $180 it stands at today. Why was he so confident? He bought SHLD not as a trade but as an investment. He saw SHLD as an investment in Eddie Lampert. He saw increasing profitability in retail operations and a growing cash hoard for Lampert to invest. Based on the 16 year track record Eddie has, that cash is in excellent hands. During the summer of 2005 none of these parameters changed and in fact he had good company as Lampert was in the market buying the stock with him!! The only risks to his investment are a fundamental change in the company’s prospects (retail operations cease to be profitable) or Lampert leaving (unlikely since he owns 60% of the stock). In this investors mind, bad news or an “analyst” downgrade that causes the stock to dip are no big deal since it then allows him to buy more at cheaper prices. All of the risks that investor #1 has are meaningless to #2. They make no difference to the long term prospects of SHLD only the price the stock trades at today. If he plans on holding this investment until one of those fundamental factors changes, the weather this winter which is negatively effecting investor #1, will be meaningless to him.

The shorter your time frame of any investment, the increased risk you face that elements having nothing to do with the fundamentals of that investment will adversely effect the value of it. As you lengthen your time frame you diminish the importance of these short term events (risk).

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GOOGLE- When will reality hit?

Yesterday I wrote about the valuation of Starbucks, a great company that is costing shareholders money not because of any management failing but because investors had bid up the price of SBUX shares to levels that are sure to disappoint. Now we turn to another high flyer, Google (GOOG).

After a 2004 IPO Google has exploded to the upside with shares going from $100 a share to the $489 they sit at today. Revenues and earnings have also jumped. Earnings grew 243% in 2005 and in 2006, it looks like earnings will grow about 75%. Revenues doubled from 2004 to 2005 and are up about 65% from 2005 to 2006. The stock was a world beater in 2005 jumping $222 (115%) but in 2006 just meandered along up only $17.92 for the year or a pedestrian 3.8%. It has a pe in the stratosphere at 62 times 2006 earnings.

Thinking of jumping on this ship? Please don’t. Why, you ask? Let’s look.

Google cannot continue to grow at this clip. The law of large numbers tell us that at a certain point, percentage growth cannot continue. At this rate Google will equal the $44 billion in revenue Microsoft took 17 years to achieve in the next 2. Won’t happen. But, Google’s stock is priced for this event. What happens when Google does not deliver this growth? The stock gets a haircut, not a trim but a haircut, who knows, maybe even a shave. Now, just because Google does not deliver this growth is not by any means an indictment of managements ability. Quite the contrary to take a company from $1.4 billion in revenue to approx. $10 billion in 3 years is quite a feat. To go from that $10 billion to $17 billion to justify the 65 pe ratio based on current growth would require a revenue increase in dollars equal to the increases in 2004 and 2005 combined! If we extend this current growth out to 2008, that would require 2008 earning to grow an additional $11.4 billion dollars (more that all the revenue from 2006).

Management is not really helping its cause here either. In 2004 when it went public Google had 277 million shares outstanding, now today we stand at 311 million. That is a 12% increase in the shares outstanding which further dilutes results on a per share basis. In this respect they are slowing their per share growth due to the dilution. These factors are headwinds working against share appreciation.

Managements actions have assumed an overvaluation of the shares. When a company believes its stock to be undervalued, they will take excess dollars and buy those shares back believing that to be the best use of that dollar. The true value of the dollar of stock is greater than the cost of one dollar. When they believe the stock to be inflated, they use it for acquisitions, the thinking being that a dollar of stock has more purchasing power than a dollar of currency due its inflated level. Google recently purchased You Tube in a $1.5 billion stock transaction.

What does all this mean? Simple, the growth rates for both revenues and earnings for Google must diminish very soon. When that happens the multiple that buyers of Google’s stock will pay will diminish with it. This will cause the price of Google’s stock to fall and fall hard from its lofty levels. I want to stress that Google is NOT expensive because it is $489 dollars a share, it is expensive because that $489 in relation to its earnings and future growth is just too much.

The average of the estimates I can find for Google for 2007 are in the range of $13.85 per share. when you consider 2006 looks to end up around $10.30 a share, kudos to management, they are delivering 33% growth. Here is your problem. The stock price has growth of 60% factored into it. What does this mean? If investors will pay 60 times earnings for a stock growing 60% a year, why would they pay that for a stock growing 1/2 that? Answer? They won’t……..

You should expect the multiple for Google to contract to a range commensurate with its growth rate. If that rate this year is around 30% expect the pe to shrink to about 30 times 2007 earnings. That give us a price for Google shares of about $450 a share. In other words, Google is overpriced. It is priced for its current growth rate, when that rate slows as it must (law of large numbers) its price will fall.

Google is a great company with a wonderful product, its stock is just too expensive.

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Why Price Matters- A case study SBUX & SHW

First things first. When I discuss “price” I do not mean the “price per share”exclusively, I mean the price per share relative to the earnings per share. After all, aren’t earnings what really matters? For instance, take companies “A” and “B”. Company A earns $1 a share and trades for $14 dollars a share (PE ratio of 14). Company “B” earns 25 cents a share and trades for only $10 a share (PE ratio of 40). A cursory look would have people think that “B” is cheaper, a share cost less. But, what are you getting for the cost of that share? Let’s pretend rather than keeping the earnings, both companies pay out all of them to shareholders at the end of the year. Company “A” would give you $1 back for a earnings yield of 7.1% ($1 in earnings / $14 price). Now company “B” does the same thing, at the end of the year you get your quarter from them for a yield of 2.5% (.25 earnings / $10 price). Per share prices aside, which stock would you rather own? Think of it this way, in order to get the same $1 back from company “B”, you would have to buy 4 shares for every one of company “A”.

Now, typically those who are invested in company “B” will say that the growth prospects for “B” are better than “A”. That while “A” may be a better value that “B” now, “B” will grow so much faster that not only will it close the gap , but the share price appreciation that will accompany this will make “B” a superior investment down the road thus it deserves the high valuation. They will cite you many examples from the 90’s where stocks like Microsoft, Cisco, Amazon, Dell and Google today and others trounced boring old companies that were bought at fair valuations. You then have to ask what happens when the music stops and the explosive growth becomes… normal?

Let’s look at how high valuations can lead to hard times for investors:

Starbucks (SBUX):

Starbucks has been one of the best performing stocks of the past 10 years. It’s growth has been extraordinary and its logo and coffee have become American icons. They provide health insurance for all their employees, use recycled paper for their cups and buy “free trade” coffee beans. In short, their is nothing not to like about the company. The stock however is another story. This past summer all was well for shareholders. The stock hit an all time high of $39 and the future looked very bright. Then a bump. The company announced its same store sales would fall well short of estimates because it had problems implementing ice new iced drink offerings during the hot summer. Rather than wait outside in line, people sought coffee from other places. Trading at over 50 times earnings at the time, investors panicked and acted first before they asked any questions and took the stock down to $29.55 a share for a 25% loss. The stock has since recovered half the loss and trades at $35 a share. Those who bought before the summer swoon are stuck holding the stock of a great company at a loss to their purchase price. Those who did not own SBUX but after the summer drop bought it are sitting on a 17% gain. Two investors, two very different situations. What happened? In a word:Fear. When you pay that much for the company, at the first sign of bad news you sell just in case the other shoe drops and that news is worse. That is what happened to SBUX. What did SBUX actually say? They had problems serving all those people fast enough. They didn’t say that there were no lines, that people only wanted the cheapest coffee they had, that they were losing market share.They only said that they could not make coffee drinks fast enough for all the demand. Now you have doubt in the stock. What if there are other problems? What else is there? Are people tired of Starbucks coffee? Despite earnings estimates for 2007 from the company that are in line with analyst’s expectations, investors are only paying 38 times 2007 earnings now (still too much). That means the stock price is falling as people are not willing to pay over 50 times earnings now that they realized SBUX is not perfect. Another misstep, not matter how trivial will lead to its multiple to shrinking again and its stock dropping more. Has anything fundamentally changed about the company? No…. It is the mindset of investors that has. If you were not smart and overpaid for SBUX, you now own a piece of a wonderful company purchased at an awful price.

Sherwin-Williams (SHW)

In a word: BORING!!. They make paint, so what? No Hollywood actors carry their cups around and you really cannot look cool ordering a gallon of red semi-gloss no matter how hard you try. Their shares have always seemed to trade in a pe range of 10 to 15 times earnings. In early 2006, a Rhode Island jury found that SHW was a “public nuisance” due to lead paint they stopped producing 50 years earlier. A judge ruled they had to share the cost of cleanup of lead paint in homes and estimates ran up to $4.5.billion in costs. Instant memories of asbestos came to investors minds and the share were punished 22% over the coming days. Investors feared a landslide of lawsuits from lead paint poisoning. After cooler head prevailed, people realized that there have only been about 2,000 cases of lead paint poisoning EVER. Once the asbestos analogy was diminished the shares resumed their normal trading at around a pe of 14 times earnings. Shares have not only recovered but are up 56% from their post Rhode Island ruling low as they have followed the earnings.

Why the difference? Valuation. SHW shares are fairly priced, bad news only effects them to the extent of the news. SBUX shares are overpriced, bad news effects them by illiciting fear and uncertainty and investors react to uncertainty by selling. Look at the two situations, SBUX is down 10% from its peak due to rather benign news, they just could not make enough coffee fast enough to satisfy the hoards. SHW is up 17% from its high water mark before the ruling, a ruling that has significantly more impact to the bottom line at SHW than SBUX’s news does. Had you paid 50 times earnings for SHW (like many did for SBUX) shares before the bad news, you would have been paying about $200 per share and would be in the hole on this stock now too. Two good companies, two negative events but for investors, two very different outcomes because of the price they paid for their shares.

Those stocks I mentioned earlier? Since 2000, the approximate top of their valuations: Dell (-44%), Amazon (-42%), Micrsoft (-45%) and Cisco (-52%) have all been losers for those who bought in…

Oh Yeah..Boring old Sherwin-Williams, whose investors never overpaid for it ? UP 240%

Buy stocks in great companies, just do not pay too much for them.

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DOW CHEMICAL (DOW) – Why Don’t You Own This?

The most fundamental tenet of value investing is buying a good company that is currently out of favor with a depressed stock price and waiting for its true value to be realized. This summer when I started looking at (and buying) DOW I just could not understand what the problem was? Why is it so cheap? What was I missing? Turns out nothing, it was everybody else who was (and still is) missing the boat here. I now wish I had done more than just dip my toes in the water then. Lesson: if you do the research, learn to trust yourself (I have bough much more since then). This summer it was disgustingly undervalued, after a 20% run since then it is only alarmingly undervalued with plenty of room to go. You can buy DOW now for the same share price you could have bought it for in 2004 despite eps more than tripling since then. Let’s discuss DOW:

Before we discuss DOW on it own merits, let just compare where it is now to its peers and see if it seems “cheap”.

—————-PE:———-Div.Yield
DOW ———-10 ————–3.7%
BASF ———-12————– 2.1%
DD ————19————— 3.0%
BAY ———–24 —————1.7%
HUN ———-31 ————–2.9%
EMN ———-13 —————2.9%

It would appear on just a simple pe level DOW is at least 20% cheaper than its closest peer (BASF) and has a dividend yield that is 23% higher than its next most generous peer (DD). The skeptics would say that the pe is low because earnings are expected to fall and the price is anticipating that. Makes sense except when you consider no analyst nor the company itself predict a decline in 2007 eps over 2006. All expect an increase. So now we have a conundrum. Why then is DOW so cheap? It must be the financials, so lets look at them:

Let’s take some 5 years averages and then look at 2006 and see how we measure up:

———————5 Year Avg. ———–Current
Net Margin ———–3.8% —————–9.7%
LTD to Cap ———–49% —————–37%
Return on Equity ——14% —————-32%
Dividend Payout ——58% —————–29%
Cash Flow Per Share –$3.76————– -$6.77

Ok, so it is not that because on those metrics, the financial engines at DOW are running full speed. So if its not the current situation at DOW then it must be something in its future prospects that we do not know. Something management is not telling us. Lets look at managements actions and see what they ARE telling us since we all know actions speak louder than words.

In July 2005 the company announced its first buyback since 1999. It said it would buy back 25 million shares before the end of 2007. DOW was so cheap in 2006 they purchased 16.8 million of the 25 million allowed (700,000 shares were purchased in 2005). In October 2006 they announced that they were adding another $2 billion to the buyback for roughly 5 million more shares. Is that all?? Of course not. In July when the stock tanked to $34 a share management stepped in with $3.5 million dollars of their own money and scooped up shares. So I guess management thinks that the future is bright, either that or you have to believe they enjoy watching their money evaporate. Doubtful.

Now we hear that private equity may be interested in DOW. Who can blame them? What do the private guys look for? They want companies that can be bought that are currently priced below their true value, even after the premium they would have to pay for DOW to shareholders. Then they can them either sell off pieces or hold it for a few years and let its value be recognized and then spin it off for a handsome profit.

Let’s take a step back now and look at what we have. We have a company trading at a discount to it’s peers, whose financial condition is the best it has been in decades, who is buying back billions of dollars of its stock, who has management spending millions of its own dollars to buy the stock, who has private equity rumored to want the whole company.

Do I really need to go any further? Next week place your buy orders for DOW please. Priced where it is, you can still get a bargin but with the private equity guy sniffing around the chance will not last long.

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Sears Holdings (SHLD), Time To Enter The Insurance Biz?

Yesterday I opined about a few retail aquisitions Mr. Lampert could consider and what he should avoid. Let go a completely different route today.

Much has been said about SHLD becoming another Berkshire Hathaway. In Berkshire’s early years, Buffett made several very diverse aquisitions. For SHLD to follow in this path, might it be time to jump outside of the retail space? Perhaps follow into Warren’s footsteps and enter the insurance business? This does have the immediate benefit of officially qualifying SHLD as a holding company and not just a pure retailer. This will change how it is veiwed and shift the focus from the current miopic hysteria over its same store sales and onto its profits and investable cash (like Berkshire) were it should be. So, if we decide to go into the insurance biz, where to look?

I enected a couple of parameters here for looking at companies. I am looking for:

  • Can it be bought with cash? I do not want to use debt to purchase something
  • Does it have relatively high insider ownership
  • Billions in investments
  • Must have low debt
  • Trade reletively cheap to insurance peers

I came up with a few:

  1. Zenith National Insurance (ZNT) Does business pricipally in California insuring the workers compensation market. Insiders own approx. 13% of the business. Earnings growth has been very strong ($67 million in 2003, $112 million in 2004, $157 million 2005, and $174 million through the first 3 quarters of 2006). Total debt now stands at $59 million, a pittance. Here is the kicker, it has an investment portfolio Eddy would now control of $2.7 billion and a market cap of only $1.7 billion. Currently it trades at a pe of only 7 times ttm earnings and 7 times next years, well below its peers. Return on equity stands a 31%.
  2. Aspen Insurance Holdings (AHL) Headquatered in Bermuda, Aspen is another attractive candidate. Insider own 9% of the business. The investment portfolio here is the story, it currently stands at $4.4 billion vs. a market cap of only $2.4 billion. It trades at only 8 times ttm earnings and only 6 times next years projected. Total debt is higher than Zenith at $250 million but low for the industry and it recently began to accelerate its stock buy back program.
  3. Mercury General Corp (MCY) Insiders own 34% of this one. The investment portfolio here is another story. It stands at roughy $4.2 billion dollars and management has earned about 4% on it for the past several years. Can you imagine what Eddy could do to this ones earnings with his ability to invest? It has a market cap of $2.8 billion. Currently trades at 13 times ttm earnings and about 11 times next years projected, still a bit below inudstry average. Total debt stands at about $145 million.

All three would make excellent additions. They can be had for below market prices and come with billions in investments for Eddy to play with. Even better, they can be had without SHLD taking on any additional debt or shareholder dilution.

An aquisition of another retailer would have SHLD valued on the potential merits of its retail operations. Should Lampert instead gobble up an insurer, I beleive SHLD’s valuation would explode to the upside as Berkshire Hathaway comparisons would have more merit and people who missed the Berkshire boat many years ago would not make the same mistake twice. This would cause a rush to buy a stock with a small public float creating massive upward pressure. Add to this the large short position in SHLD and you could have a move to the upside that could bust many of the shorts.

Either way, this will be very interesting…..

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Sears Holdings (SHLD), What Will Eddy Do?

OK, so we expect SHLD to have about $3.5 billion in its piggy bank at the end of the quarter. time to go shopping? I think so. If we are, what makes sense?

  • Invest More In Current Locations: NO!! the current program is working just fine. Lets not forget when Eddy bought Kmart it was fresh out of bankruptcy with bleak prospects and Sears was heading there when he bought it. Now the combined entity is throwing off almost a billion a year in profits. What is the problem? As an investor, the number of sweaters they sell does me no good, the money they make from those sweaters does. Eddy talks of the same store sale fallacy retail metric here: http://www.searsholdings.com/invest/ . Read it carefully to get an idea of the direction he is taking both Sears and Kmart. He has no vision of either of them growing into a colossus. What he wants is for them to become as profitable as possible to provide him $$ to grow Sears Holdings. It is a subtle but very important difference. If you have been to a Sears that has the Land’s End “store in a store” concept, it is a great change.
  • Buy Home Depot: NO!! HD was a great value play 2 years ago. Not anymore. Add to this the current hostility towards the board of shareholders (they would almost certainly reject any recommended offer from the board, forcing a hostile bid) and you have the making of a very long, expensive process, nothing Eddy wants
  • Buy BJ’S: Dare to dream? This would wonderful. At its current valuation Eddy could write a check for it. It would add almost a dollar a share to next years earnings (adding another 10% growth) without making any assumptions on the financial benefits of synergies. The synergies there are exciting. We would be able to sell more Craftsmen and Kenmore items in BJ’s. Think also of the Sears / Kmart apparel line that could also be sold through BJ’s. Picture a Land’s End closeout section in BJ’s. BJ’s also sells home heating oil in the northeast. The purchase of this would go nicely with Sears service agreements on home heating and cooling systems. Once in the door, sell windows, siding etc. Same with BJ’s auto service locations, picture all the extra Die Hard batteries we could sell . The increase in assets due to BJ’S real estate holding would be a plus for us in a leveraged play later on if he wished. Another oft overlooked plus: we could instead of selling the under performing Kmart and Sears locations, convert them to BJ’s and in one fell swoop preserve the asset base and increase profits. The conversion from a Kmart or Sears to BJ’s would be dirt cheap. Just gut it and stock it… they are warehouses for crying out loud!! Eddy are you listening? I have a real hard time finding any negatives to this scenario.
  • Buy Radio Shack: Until last night I though this was just a desperate idea being floated out there, then we scooped John Warren from Best Buy. The knock on The Shack has always been a disconnect between it and its customers. I had not seen anyone at SHLD capable of effectively fixing that (since its own electronics dept. is no world beater). Mr. Warren is arguably the best out there today in the electronics world at??? Consumer Relations … HMMMMMM. That does get the wheels turning. Why would would you raid the #1 electronics retailer for their #1 consumer guy? It must have cost a pretty penny. I am sure that you want to improve your own operations but electronics is only a portion or our business, can he really make that much of a difference? Unless maybe you are planning on buying an electronics retailer with a troubled history defining itself. If you look at the Shack currently Julian Day is turning the books around there. Cash is growing ($225 million to $450 million, profits look to go from 30 cents a share to almost 90 cents next year, but same store sales are falling (does any of this sound familiar?) Did I mention Mr. Day is a former SHLD exec? It would appear that maybe you at SHLD are preparing to make a purchase in this area and want your ducks in a row first. This purchase would vault us to the #2 electronics retailer over night. Might Mr. Warren’s desire be to the then make us #1 over his old friends at Best Buy? This is yet another purchase Eddy could do with a check and would have friends in management there to make it happen. It would add 30 to 40 cents a share to next years earnings again assuming no financial benefits to the obvious synergies. This one is starting to excite me now..
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