Whopper put up a post recently on McRae Industries discussing the investment potential. Whopper does a nice job laying out why someone would potentially want to invest based on financial metrics. My quibble with the post has nothing to do with his reasoning or any accounting aspects but with this line
"McRae sells boots. We could go into a further breakdown of what they do, but there’s honestly no need. As you might expect of a company in the boot industry, McRae is pretty much a commodity company with commodity company like returns."
I think often value investors get stuck in a rut, they do a lot of research, reading company financial statements, reading about competitors (through financial statements), and reading about industry segments. Left out of this process is the thought or connection that the business under the microscope is a collection of real people who gather in an office each day, talk about American Idol, gossip about each other, surf Facebook, all while taking customer calls and complaining about their boss. As Avner Mandelman talks about in the The Sleuth Investor
(highly recommended) a business is a place where people send checks. He asks whether the customer being served is worthy (do they deserve to be served?), and how they're served (the business process), along with things like who is the customer, and who are the managers. The Sleuth Investor really dives into looking at the physical aspect of a company, visiting the plant, talking to workers on their lunch break, and buying their product like a customer would and talking to customers if possible.I know these things seem strange for most investors, especially value investors who model their behavior after Ben Graham who rarely talked to a company or Walter Schloss who almost never talked to companies. Ultimately though I don't believe either of them had the detached mentality that has developed amongst a lot of value investors today.
The result of this detached mentality and focus only on financials is what sucked a lot of value investors into China RTO stocks. On paper these companies looked like absolute steals. Companies trading for less than cash, growth rates of 30-40% a year selling toasters. Ultimately a lot of these companies were undone by investors who did the physical checks of these companies. While vilified there is a lot to be said about Carson Block who counted trucks, talked to customers and sleuthed factories. It wouldn't surprise me if Block has read the Sleuth Investor a few times. The physical reality didn't jive with the financial statements and everything came undone. The opposite could also be true for some companies, the physical could be much better than statements suggest offering a great opportunity for an investor.
The ideas in the Sleuth Investor resonated with me, probably because I work in the business world, deal with small and large companies daily and am mostly detached from the investment world (outside of this blog, twitter, and some emails). My friends all work for various companies in non finance roles, to them investing is reserved for smart people in New York and London who wear suits to work everyday. Investment to most people isn't P/B, ROE, or ROIC, it's buying a new machine to reduce lead time, streamlining distribution channels, or removing inefficiencies from a business process. These are the tangible, physical things that drive a company's financial return.
For a while now I try to answer the question "Why is a company cheap?" when I research a business. In looking at this question I was getting part way to answering some of the questions about the business itself, but not all the way there.
Why is this important?
Looking at a business as a physical group of people who collect checks for doing some sort of task opens the mind to think about a company differently. My main goal in investing is to not lose money. If I find a cheap stock and then look at pictures of it's facilities and realize they are decrepit and in disrepair I stand a chance of losing my investment. I want the physical reality to confirm the financial reality of the company.
Other times thinking outside financial statements gives reasons as to why a stock might be cheap. Consider a company located far from an airport, railroad or major urban area. They might need to truck parts in, and truck out a finished product. If gas prices rise they are impacted to a much greater extent then a company located in a major city, or near an airport with a short haul. None of these things are mentioned in the 10-K, but are easy to find just looking on Google Maps.
A lot of people will dismiss this post saying that if a stock is cheap it doesn't matter what the business does, or how it does it. I can agree at a point, for Japanese net-net's I have had trouble getting a solid grasp of what these businesses do, so I will invest on metrics. This is fine, but I recognize that it's a somewhat mechanical strategy. Even so, some basic Googeling can result in a lot of information, even about businesses overseas.
It seems crazy but even for a net-net I think examining the physical business is important, I looked at this with my post on Hickok. A small amount of time, such as 30-45 minutes of looking at maps, street view, and reading about an area online can give great insight to an investment. Often this sort of in depth research seems to be reserved to people who concentrate hundreds of thousands or millions of dollars into a few investments. I think it should be considered by all investors regardless of the investment size. Relatively simple physical checks can yield really good results.
If feasible I think it's even worth trying to buy a product, or at least examining it. Call the company and act like a client. I tried this with AEY, they ignored me. I tried to get quotes on a few pieces of equipment. If they ignored me why would my experience be any different from any other potential client?
I think the level of research outside of financials probably scales with the size of an investment. For someone putting $500 into a net-net a quick look on Google Maps and reading product reviews is fine. For a $100,000 investment I'd expect the investor to at least have handled the product (if possible). Think of it like this, for a few hundred dollars you could avoid a potential thousand dollar loss or more.
Putting it in Action
So I want to just consider a few questions about McRae in the vein of this post.
Where are the boots manufactured? - The army boots are manufactured in the US, the cowboy boots appear to be manufactured overseas. This raises a whole other host of questions regarding leather availability in China (an issue facing Danier Leather).
Who buys these boots? - Identifying the customer is critical. It appears there are probably four customers, soldiers, horse riders, industrial users, and possibly fashion buyers.
How easy are they purchased? - I was unable to find a way to purchase the boots online, they appear to only be sold in stores (why is this?). I did a search of stores near where I live. The closest one is a western apparel store right up the road. So here's my impression, this western store is a place that my wife and I comment about each time we drive by, there are never any cars there, and we don't know how they stay in business. Other friends have made similar comments.
Looking at the western store prompted another thought, these boots will probably never be purchased as a fashion item. I know if I was looking at boots I would not go to the western store due to the stigma attached, I'd probably look online. So the product doesn't have a big general market from what I can see.
Is the brand known to people who would likely use the product? - No idea, this would need to be further researched.
Why buy McRae boots over a competitor? - Again no idea.
This is just a start, and these are some of the things we need to think about when looking at companies. I know I'm guilty and have been of paying lip service to the fact that stocks are companies. Heck, this post is more of a reminder to myself than anything else. I think as investors we need to look at a stock as a business first, and the financial component as just that, a component. I know one value investor who has been putting these sorts of questions into action is Richard Beddard over at the Interactive Investor Blog. This is an area I want to get better at myself.
If you are interested in the financial aspect of McRae I'd check out the Whopper link above and the great post at OTC Adventures here.
Questions, comments? Talk to Nate
Disclosure: I make a small commission if you buy the Sleuth Investor through Amazon.com. There is no markup on the book if you visit through my link verses going to Amazon.com directly. I purchased this book on my own on the recommendation of someone on the Corner of Berkshire and Fairfax message board.
