I rarely discuss things I do because what I do isn't what you do unless you are copying me in which case you're missing the point of this blog - to help you learn to do this yourself. But sometimes I will put up something I just did after its done and what you do won't affect what I do. Sasha wrote me that she's long GMCR so I thought I'd put up some information about GMCR that she may have missed.
Ten days ago, David Einhorn made a deadly presentation at the Value Investing Congress that just killed the stock. He basically said two things:
1. It is engaged in fraudulent booking of sales that don't exist
2. Its patents run out in 2012 and competition is going to kill its growth. His conclusion is GMCR can not sustain these lofty multiples and must come down. Here's his presentation.
Meanwhile, Sasha said this about GMCR: "On the other hand some things from my past "carry over " my preferences- now that's abstract. In other words it's a process: the more I work on it the better I get. Example: GMCR -it's testing my guts, my meaning, my knowledge, my money."
In other words, she's long GMCR and it is taking a beating so let's take a look at this thing:
First, Meaning: Melissa and I like GMCR product. We have two of their coffee makers and we drink their coffee. I understand why people like this product. It is the future of a big segment of coffee. I wanted a piece of this thing. But paying a high price for a rosy consensus, as Buffett sometimes says, has a lot of risk, even when it seems its a good story. I couldn't make sense of some bad Moat numbers and weak Management numbers. OCPS Growth is all red, all the time for ten years. Note below that ROE is good but on the low end and dropping while ROIC is in the yellow and dropping. Debt is too high. Big red flags. (Numbers from Rule One tools).
These things don't drop a company off my radar screen on their own. What they do is lead to some digging. Here's the cash flow statement for 2010:
Its hard to miss that GMCR Cash from Operating Activities (OCPS on the Rule One tools above) is negative. You can see above that Receivables and Payables are going in the wrong direction. Negative cash is usually a bad sign. GMCR attributes it to growth but perhaps this is a managment problem and requires more digging. But before that, check the price valuation relationship. Is this thing buyable?
Here's the Rule One tool for valuing a company using two techniques: the Margin of Safety analysis is based on my version of a discounted cash flow model (See my book, 'Rule #1', for clarification) and Payback Time, based on the time to recover the current price from earnings (a private equity calculation of value for buying the entire company. See my book 'Payback Time' for more information.)
The price chart shows the price in the red. This means that based on the MOS calculation the price is at least 20% over the Sticker Price and indicates its time to sell it.
I did the MOS based on reasonably optimistic assumptions of growth - 20% per year with a 40 PE. Remember I'm looking way out there - 10 to 15 years of sustained growth compounding. 20% per year is a lot of growth. It requires the company become 8 times larger in 10 years. Few companies have sustained that rate for that long so this is not a conservative valuation.
What this page shows is GMCR has a Sticker Price of $31.22 a share (if its not fraudulent and if the growth is sustained). I should try to buy this at $15.61 MOS Price. But if I want to be more conservative and pay a private equity price, I should try to buy it with an 8 year Payback Time Price of $10.10. The Payback Time of the current price of $69.61 (as I write this - it was quite a lot higher last week) is quite a lot more than ten years, my outside limit.
These numbers kept me out of GMCR. I didn't short it because it is dangerous to short a growth story. Mr. Market can be irrational longer than I have money. But when Einhorn laid it out that the short case was about a lot more than just a too hot price, it was easy to jump on it having already seen that issues were showing up in the numbers and that it was massively over-priced if my assumptions were correct about long-term growth. (Always do your own work. Do NOT rely on my estimates of anything. I have been wrong in the past. I will be wrong in the future. I'm probably wrong now. Make up your own mind.)
If you own it, what should you do? First, forget what you've gained or lost. Look at what's in your portfolio as if you are being asked to advise a good friend whether to buy more, hold on or sell. Sometimes consulting to yourself will get you past the emotions and keep you more rational.
I met with Whitney Tilson on Sunday and learned he was shorting GMCR. I looked at the numbers and decided to dig in more on Monday. Monday morning I watched Einhorn do his presentation and half way through I started trying to get a cell signal to short it. Couldn't. I ran upstairs to my room at the end of his presentation and put the short on. The stock had already dropped from $90 to $82 while David was speaking. I got in by selling it at $82, pretty certain it was going to be a long wait for a final outcome. It wasn't.
The stock dropped daily until two days ago when it hit $57. A look at the chart showed $57 was a significant technical Floor, I was way in the black on the trade and it was moving back up so I bought it back at $58.
Thank you David, Whitney and Glenn.
Now go play.
