I embark on this investing travelogue with a considerable amount of
trepidation: First off, the exercise could be viewed as entirely
narcissistic. Secondly, the figures I am about to divulge are not
matters of public record, therefore the veracity of the numbers could
easily come into question. After all, it would not be the first time
that a writer invented figures to suit his purposes.
I decided to
push the aforementioned apprehensions aside and proceed with my story
since I believe it can serve as an inspiration to younger and
disgruntled investors. Further, I believe the essays will establish with
a high degree of certainty that value investing actually works and
equally important, that value investing is a lifelong learning process.
When I embarked upon my investing career around 20 years ago, I was a
buffoon (the first three stocks I purchased were gold junior mining
stocks - more on that later). Fortunately for me, I was able to
transcend the line that separates a cretin from a competent investor
before I had obliterated my life savings. That process required an
extensive amount of humility as well as a strong commitment to learn
from my mistakes.
Today's edition will profile my early investment years which upon
further recollection, started in 1994--maybe I should change the title
of the series to "Reflections from 19 Years of Investing". The series
will be written informally and serve as sort of an investment diary
which chronicles my evolution as a value investor. As the title
suggests, today's discussion will cover the period from 1994 to the end
I still remember the names of the first three stocks that I
purchased nearly 20 years ago. They gold mining companies: Pegasus Gold,
Eco Bay Mines and Battle Mountain. I came to purchase the stocks after
consulting with one of the telemarketers at the home improvement company
where I was employed as a commission salesman. Now "that takes some
explaining Lucy." You see, the telemarketer was a former Wall Street
investment adviser who developed a nasty cocaine habit and served
multiple tours of duties at some of the finest rehab facilities in the
U.S., apparently to no avail.
Although at the time I was talking
to him, he appeared to be on the straight and narrow, in reality, he
was heading straight to his supplier with money that he borrowed from a
number of his co-workers which included me. For informational value,
never loan money to an "ex-junkie" who consistently wears long-sleeve
shirts that cover the entire back of his hands - I never saw more than
the guy's fingernails. You see he shot up his medicine through the veins
on the back of his hands. Please forgive my temporary digression.
the drug addict gave me the 800 number of one of his former cohorts who
happened to be a gold bug, and the rest is history - so was two-thirds
of my $15,000 "investment" after a matter of months. For younger
readers, gold and gold mining stocks were not the place to be in the
1990s, as gold steadily plummeted to less than $250 an ounce.
by the loss, I abandoned the gold mining sector and invested my
remaining $5,000 in Intel (INTC). Why Intel you might ask? To the best
of my recollection, I had heard a number of analysts talking about the
stock on CNBC and unlike many of the other technology stocks, it
appeared to me to be cheap. I have no idea how I came to that conclusion
since I had no ability to price equities at the time. I was still in
stock picking kindergarten and the concept of a PE ratio was entirely
over my head, let alone the concept of free cash flow or return on
As fate would have it, Intel tripled in about a year and
my bank roll was miraculously restored with my only loss being the time
value of my money. Bear in mind that saving accounts actually paid
interest 20 years ago.
2001-2008 (part 1)
I resume the story in early August of 2001, about one month prior to one
of the saddest days in American history, Sept. 11, 2001. For some
reason I had suddenly become very apprehensive about the market and for
one of the few times in my investing career, I acted completely on
impulse. I sold out of about 60 percent of my stock positions. I simply
called up my broker one morning (I was not doing my transactions on line
at that point) and read off the list companies which I wanted to delete
from my investment portfolios.
I recall one thing in particular about going to such a heavy position in
cash: It made my life extremely boring for the next few weeks. Still, I
held tight to my resolution that I would not make any further
investments until the market corrected and I temporarily quit doing
stock research altogether. The decision was extremely foolish since it
was based upon pure speculation rather than any analysis about the
valuations of my holdings. As things would turn out, I did not have to
wait before the market corrected.
Like most Americans, I remember exactly what I was doing on Sept. 11,
2001; I was watching CNBC as the horrific drama unfolded. I will never
forget watching the backdrop of the Twin Towers when the second plane
hit; at that point it was evident to all Americans that their country
was under siege from terrorists. Mark Haynes navigated the viewing
audience through the terrible ordeal with exquisite poise, never
cracking or wavering as Americans sat mesmerized in front of their
television sets, watching the shocking developments in stunned silence.
September 11 had a profound effect on the psyche of Americans
and without question it had a dramatic influence on their buying and
spending patterns. About a month after the attack I attended the Fall
Home Show in Omaha and almost none of the vendors did any significant
business with one notable exception. The man who sold America flags and
retractable flag poles sold out his entire inventory quickly. Many of
his customers were forced to endure back order periods of several months
before they were able to openly display their love for the United
The tragedy had reawakened the patriotic spirit of the
American people, drawing its citizens closer together; although it also
triggered some temporary changes in their behavior. Americans became
much less apt to travel long distances for an extended period, following
the tragedy. Airplane traffic dropped dramatically and the following
year, businesses which relied upon tourist traffic during the summer
months would suffer mightily. It appeared that September 11 had
significantly reduced the desire of many Americans to spend their money
on things pertaining to leisure and entertainment or much of anything
else that did not reflect upon their basic needs. Fortunately, the
effects of the attack on the American economy would be temporary in
After the shock and sadness of September 11 began to
wane a few days later, I resolved that I was going to spend all my
available doing stock research. Free time had become an abundant
commodity as my business phone had gone silence following the attack. I
began purchasing stocks a few weeks following the tragedy, and within
about a month, I was once again fully invested. I would remain fully
invested in equities for longer than a decade.
After reinvesting all my funds back into stocks shortly after September
11, I enjoyed a stellar performance until the market engaged in a severe
correction in the late summer and early fall of 2002. Following
September 11, my portfolios advanced about 25% by year end and by the
mid summer of 2002, they had advanced by over 55 percent. Bear in mind
that I had never enjoyed any real success in investing prior to that
point; therefore I was developing a bit of a “Messiah Complex.”
Legendary turf writer Andrew Beyer coined that term to describe the
tendency of a horse player to become overconfident following a
successful run of luck at the race track.
The late summer of 2002
quickly destroyed any personal delusions I held about shutting down my
business and living off my investments. I lost every cent of the 55% in
paper gains which I had recorded following September 11 in approximately
Another problem presented itself: My wife was now in
full scale panic mode and she was putting me under extreme pressure to
sell out of all our equities “while we still had something left.” It
seems that she had been talking with one of her friends who had recently
gone to cash in her 401-K after knuckling under to the pressure of a
rapidly dropping market. My wife thought it would be much more prudent
to buy a larger house than to invest our life savings in the market.
for us, I refused to knuckle under and resolved not to sell any of our
positions. The process was greatly aided by the fact that the market
turned almost exactly at the point of my wife’s heaviest insistence to
liquidate our positions. In the future, I would use her as a “contrarian
indicator” and I made a special point to remind her of her wholesale
panic whenever she became nervous in regard to a falling market. The
experience became extremely important about six years later when the
credit crisis developed and our portfolios would lose well over half of
their value in a few short months. To her credit, she weathered that
storm extremely well.
After the market reversed in the early fall
of 2002, our portfolios began an unprecedented run of good fortune. In
2003, the portfolios were up in excess of 80% and by October of 2007
they had more than quadrupled from their trough, around early October of
2002. It was a great five year run; although I never anticipated that
approximately that one year later, the majority of those gains would be
sacrificed in merely a few short months. But that is a story to be told
later in the series.
By 2003 I was developing quit an affinity for purchasing microcap
stocks. Apparently, my early experience with Camtek had not destroyed my
interest in investing in tiny companies. I decided that I would start
investing significant capital in microcap stocks for the following
reasons: They were largely under appreciated and under followed by the
investing community, and they were more apt to be mispriced than their
I started following a rather sleazy microcap
tout service which was later exposed by Barron’s; the service was
Ceocast.com. The newsletter did not charge its reading audience a fee;
rather they billed the companies which they promoted in the form of cash
and shares of their stock. The “pump sheet” was full of extremely
low-grade companies which typically traded on the Bulletin Board;
however occasionally they would promote a real “diamond-in-the-rough”
which traded on a reputable exchange.
Lake Gaming (LACO)
originally discovered Lake Gaming in the Ceocast newsletter and I
eventually purchased shares in the stock, but not for the reasons which
the newsletter discussed. Upon reviewing the company, I noticed that Mario Gabelli held a significant position in the stock and it was trading at less than 50% of its tangible book value.
it turned out, one the major assets the company held, was land on the
far south portion of Las Vegas, in close proximity to the airport; they
were in the process of monetizing that interest by selling the property
to time-share companies. The scenario was reminiscent of Aztar.
Furthermore, their balance sheet held significant cash and large amounts
of money which was owed to them by certain Indian tribes.
the end of 2002 the company had a book value in excess of 15 dollars per
share. I bought my original position for around 7 dollars a share and
following the announcement of non-cash accounting restatement, which had
no effect on the book value; the stock dipped to about 4 dollars a
share. I doubled my position at around $4.25 per share.
on my side in the case of LACO; although their Indian Gaming business
would not drive their earnings in the near term, another catalyst was
about to emerge in early 2003. Lyle Berman, the CEO of LACO was an avid
poker player and he had an idea that provided the impetus for the stock
to move forward.
Berman pioneered the idea of the World Poker
Tour (WPT) and sold the concept to the Travel Channel. Watching poker on
television had always been boring since the viewing audience could not
see the down cards which the players held. Berman remedied that problem
by allowing a camera to expose the down cards to the TV audience. That
idea suddenly transformed Texas Holdem into a fascinating spectator’s
sport. By the end of 2003 the stock had reached its book value of 15
dollars a share and I decided to take my profits, perhaps a bit
prematurely. The stock quickly climbed to about 30 dollars a share on
In the longer term, the decision to sell turned
out to be prudent since the TV success of the WPT never translated into
significant profits. The idea may have revolutionized the TV viewing of
poker events but it never turned LACO into a cash cow.
I will conclude today’s discussion with another balance sheet play that
resulted in my largest gain at that point in my investing career. The
company was Fairchild and I had started accumulating shares in the
company, following my reentry to the stock market in the fall of 2001.
It was another company in which Mario Gabelli
held a significant position. I can not recall for certain, but I
believe the stock was mentioned by Gabelli on CNBC. As is typical with a
Gabelli holding, the stock held real estate which was understated on
the balance sheet. Specifically, the company owned a large shopping
center in Long Island which was almost fully occupied and provided the
heavily debt-burdened company with a steady cash flow.
held another asset which was extremely undervalued and held a much high
intrinsic net worth than the shopping center. More specifically,
Fairchild owned a large airplane fastener company which had recorded
well over a half a billion dollars in sales in fiscal year 2002 and was
returning the company over 70 million a year in EBITDA.
the reasons Gabelli liked Fairchild was due to the fact they were
extremely overleveraged. That may sound strange but “The Chairman”
believed that the CEO and controlling shareholder, Jeffrey Steiner,
would be required to do a deal to prevent the holding company from being
forced into bankruptcy proceedings.
Steiner had a reputation
for several things: Most importantly, he could be described as a very
successful wheeler/dealer that was known for buying businesses and later
selling them for a tidy profit. Secondly, he was one of the most
notoriously overcompensated CEOs on Wall Street and he controlled the
board of directors at Fairchild.
When he made a successful deal
he was handsomely rewarded in the form of a bonus as well as drawing an
excessive base salary. Steiner’s legendary greed was profiled in
newspaper articles, business magazines and was even the subject of an
entire chapter from the book: "In Search of Excess: The Overcompensation
of American Executives".
I bought a large position in Fairchild
at around three dollars and when the company dropped to slightly over $2
a share I bought considerably more stock. At that point in my investing
career is seems that I was fearless. I as recall, the company
represented nearly 20% of my entire holdings when I was finished
purchasing the stock. Never before had I taken such a large position as a
percentage of my entire portfolios.
In mid July of 2002, I awoke
and turned on my living room television set; scrolling across the
bottom of the CNBC ticker was the following headline: Alcoa buys Fairchild’s fastener division for 657 million in cash. I
jumped so high that I almost hit the 8-foot ceiling in my living room.
It seems I had hit the mother lode on Fairchild in less than a year’s
When I performed the calculations, I figured that the sale
alone should be worth at least $6.50 a share to the Fairchild
shareholders but the stock quickly settled under six dollars per share. I
pondered the situation carefully and decided that Steiner would never
return a dime to the Fairchild shareholders. I sold my entire position
at around $5.50 a share, deciding to pay the short capital gains taxes
on the shares in my taxable accounts.
The decision turned out to
be prudent since Steiner eventually squandered the entire windfall
without returning a dime to the shareholders. Of course he received a
tens of millions as a finder’s fee for executing the transaction.
Gabelli on the other hand, decided to maintain his entire position. For
once I had out thought “The Chairman.”
dropped slowly and steadily, never again reaching the five dollar range.
Following the death of Jeffrey Steiner, the company was liquidated at a
small percentage of its former price. As I recall it brought a little
over a dollar a share.
*** 2001-2008 (part 2)
I was brimming with confidence entering 2004; I had just recorded
my best year ever in terms of gains versus the S&P. All the market
indices had recorded a resounding rally since the early fall of 2002;
the rally was fueled by the Federal Reserve’s monetary easing policy and
a new found optimism about future of corporate profits. It seemed that
the tragedy of September 11 was now a distant memory and its effects on
the psyche of the US consumer had all but disappeared.
Following precipitous market rallies, value investors must devote
increasing research time to uncover bargains. Such was the case in 2004,
many of the obvious values had disappeared and simple asset plays, as
well as beaten down cyclical stocks were quickly vanishing from the
screens of value investors.
During such times, investors
either have to become more imaginative in regard to uncovering value
propositions, or reduce the number of companies that they hold in their
portfolios. At that point in my investing career, I still lacked the
confidence to hold just a few large positions; thus I decided to become
more creative in my investments. I starting searching for theme
investments which I thought would prosper during the cyclical recovery.
The Investing Climate in 2003-2007
Oil, natural gas and other commodities were entering a bull market,
driving up the value of the companies who owned or leased the land which
held the resources. Oil service and equipment stocks as well as the
mining equipment companies would benefit mightily as the demand for
their products and services rose dramatically.
with the housing market, not only were home builders and banks
benefiting from the housing boom, so too were the building material
suppliers and virtually any business which was related to the worldwide
surge in housing market.
I started to focus upon finding
companies that would benefit from the aforementioned investment themes,
but only investing in companies which still held reasonable valuation
metrics. The idea was to locate companies that remained undiscovered by
Wall Street which were likely to increase their forward earnings. Furthermore, such companies would frequently become buyout candidates,
as larger companies looked to increase their earnings by acquiring
businesses that were not already “sky high” in price.
I would check the ownership of many of the companies that I found to be
worthy of research, I frequently ran across the name of Jeffrey Gendell
who titled his hedge fund Tontine Asset Management.
The Rise and Fall of Tontine Asset Management and ENGlobal (ENG)
Gendell rarely conducted interviews, almost never publicizing his stock
selections or his theories in regard to investing. The average investor
had never heard of him or his hedge fund; however anyone who tracked
money managers closely, was well aware the outstanding returns which
were flowing into the pockets of the clients at Tontine. In 2003 and
2004, Gendell recorded near miraculous gains, approximately doubling the
value of his portfolios, in back to back years.
first caught the eye of Wall Street when he became extremely bullish on
US steel companies in the early 2000s. Similar to today, US steel
companies were on the outs with investors and Tontine boldly stepped in,
heavily overweighting the sector. Shortly after Gendell entered the
sector, steel companies began a protracted bull market; it seems that
Wall Street had a brand new emerging superstar that was capable of
spotting cyclical bottoms as well as possessing sufficient courageous to
act upon his convictions.
The prodigious gains of Gendell
caught my eye as well, and I began to track the companies in which he
held significant ownership. One of the companies that I ran across was
tiny ENGlobal (ENG), a
Houston-based provider of engineering services to the energy sector. The
stock fit my investing theme perfectly and it did not hurt my
confidence to know that Gendell felt the same way. Further, the stock
appeared to be reasonably valued in terms of the business the company
was writing and I believed that its earnings were about ready to spike
upward. As you can see, I was not exactly demanding a large margin of
safety in my theme investments at that point in time.
purchased ENG in the spring of 2005 for $2.20 a share; by the mid to
late summer of the same year, the stock had climbed to around 9.00 a
share. I now had to make a decision on whether to sell the stock and
take my gains or continue to hold the stock. As it turns out my decision
was made considerably easier when I turned on Mad Money that night and
much to my amazement, Jim Cramer was touting this tiny microcap stock.
My decision was now etched in stone; I sold ENG at the open of the
market the following day, for exactly 9.00 per share.
had been my experience that Cramer’s late entry into a momentum stocks
generally resulted in a market top for the equity. Such was the case
with ENG, after the price ascended slightly higher, the stock quickly
dropped below 7 dollars a share. In fairness to Cramer, the stock did go
much higher several years later but that was a merely temporary spike,
the case of a low quality company hitting a temporary sweet spot. A few
years later the stock steadily dropped and never recovered; today it
trades under a dollar a share.
Now back to the saga of
Jeffrey Gendell and Tontine Asset Management. It seemed that Mr. Gendell
was not adhering to Ben Graham’s prime directive which suggested that
investors should minimize their risk by demanding a sufficient margin of
safety on their investment selections. Not only was the hedge fund
highly leveraged but almost his entire portfolio was concentrated in
debt-laden cyclical companies which were currently benefiting from
rising real estate and commodity prices. Apparently, Gendell simply did
not believe that the bull market which was triggered by the real estate
bubble and the boom cycle in commodities was going to end any time soon.
To make a long story short, in early 2009 Tontine was
forced into liquidating its positions and shutting down the fund. I
noticed one of the stocks that Gendell was forced to sell was ENG—I
wonder if Cramer was still holding the stock? The experience served as a
lesson for all investors (me included) who might decide to coat-tail a
respected investor without regard to performing their own due diligence
on the guru’s stock purchases. The Gendell saga also exposed the extreme
danger of employing excessive margin in the hopes of “juicing” one’s
2001-2008 (Part 3)
Reflections from 20 Years of Investing (2008-2009)
Reflections from 20 Years of Investing (2010 and Beyond)
The financial crisis of late 2008 and early 2009 had a profound effect
on the future investing strategy which I would employ going forward. It
literally changed my entire outlook on value investing; I would became a
balance sheet oriented investor who held large concentrations in a
limited amount of stocks.
The credit crisis had served to remind
me of Buffett’s three most importance words in investing: margin of
safety. It seemed that my investing success had caused me to lose sight
of the potential downside in a stock purchase. That failing had caused
me to temporarily underperform the market during the Great Recession. It
also had injected an elevated level of risk into my investment
portfolios which I was unable to tolerate. The remedy involved making
fewer investments and demanding a higher margin of safety.