A few weeks ago, I talked about how one of Warren Buffett's shareholder letters illustrated that fewer holdings can sometimes bring better results. To follow up, here are some other cases in which less can be more.
When negative is positive
The stock market's infatuation with same-store sales, or comps, can be a huge opportunity for intelligent investors. Some have made a bundle waiting for negative comps to hammer shares of stalwart retailers, such as teen apparel manufacturers Abercrombie & Fitch
But for various reasons, the comps metric is often meaningless. First, the time period it measures -- usually a month -- is way too short. Second, same-store sales often don't adjust for changes in capital spending, and thus don't correlate with returns on capital. Finally, companies account for comps in different ways, and they often don't acknowledge that new stores may take years to ramp up, vastly distorting comps results.
The best example of a previous "negative comps" opportunity is Sears Holdings
How is this possible? Well, Sears was eliminating unprofitable sales, which helped it generate a torrent of cash flow. It used that money to buy back its own shares and shrink its capital base. Meanwhile, its real estate holdings have continued to appreciate.
Along those lines, investors might want to keep an eye on RadioShack
When life gives you lemons...
Among hotels and restaurants, less can be more in a big way. In 2002, Julia Stewart became CEO of IHOP
The plan worked to perfection, and IHOP's stock has nearly tripled over the past five years. Recently, IHOP agreed to acquire Applebee's
Over the seven years following the deal, Hilton's owned hotel rooms dropped nearly 20%, while franchised hotel rooms increased almost 70%. In that same time period, Hilton's stock has nearly quintupled. The company's now being bought out by Blackstone.
I still find it amazing that huge corporations pay so much attention to sales growth comparisons, and so little attention to returns on capital. Whenever you study a company, note whether it emphasizes the latter. If not, watch out; shares could be stuck in neutral for awhile.
On the other hand, if you notice that a company plans to switch from an asset-intensive model to an asset-light model, pay very close attention. Shares could be revalued upward as returns on capital and free cash flows improve.