Greedy When Fearful

  Investing just $500 in Pier 1 Imports (PIR) in March 2009 would now be worth $50,000. A hundred bagger. Investing $500 in K-Mart in June 2003 turned into $2500 in February 2005.  A five bagger. Why does the world need Pier 1? Why would anyone go to K-Mart? The world doesn’t. These businesses could have disappeared and nobody would have noticed, yet these were incredible investments. Why? Walking Dead Valuation.  Pier 1 had a market cap of 10 million in 2009, and K-Mart about 1.5 billion in 2003. Pier 1 was on the brink of bankruptcy after 17 consecutive quarters of declining sales. K-Mart went bankrupt, and re-emerged in 2003 with the smaller market cap. Those that bought K-Mart before bankruptcy lost their investment, those that bought after, a five bagger. This is why I spend a few minutes every day scanning the 52 week low lists, because you only need to find one zombie that comes back to life, and it can add a powerful secret sauce to your core portfolio of index funds and blue chips.  Even if you do invest in a company that goes bankrupt, at least you are paying attention to the story. If it ever re-emerges, like K-Mart, you can buy back in and make your money back as it returns to profitability. Why It Only Takes One Predicting the future is impossible. However, by buying a basket, math is one your side. Imagine a basket in your portfolio as one very small investment, let’s call this the Bankrupt Mall Basket. It’s holding a bunch of failing companies instead of eggs. In this basket is four companies, $1,000 invested in each. If three go bankrupt, and only one turns around and becomes a 7 bagger, that $4,000 original investment becomes $7,000. That’s a 75% failure rate, and yet you still almost doubled your money.

Now, I think this basket will do a little better than a 75% failure rate.  That’s why over the next 5-10 years I think this mall basket will at least double. This has been my most successful investing strategy (thanks Buffett!). It worked in the past on AIG, Bank Of America, BP, Netflix, Ford, First Solar, Supervalu.  My failures, like Blockbuster and GM, don’t matter because of how math works. Your losers can only lose 100%, but your winners? The upside is infinite. Through diversification of many small bets combined with time (at least 5 years), your basket will eventually be filled with golden eggs. Finding The One I don’t use traditional valuation strategies when investing in turnarounds. I have found these key factors are most important to success

• Strong consumer brand. Does your non-investing co-worker and family member know the brand? If the answer is yes, congratulations! You have found yourself a strong consumer brand.
• Everyone hates it. The media is writing about yet another bad quarter. Your friends no longer buy their products. Everyone predicts the brand is dead. Stores are closing. You are laughed at when you tell someone you bought shares of the company.
• Low market cap. The lower the better, typically 1 billion or less.
• 52 week low to 52 week high spread. The greater the distance between the 52 week low price and the 52 week high price, the better.
• Buying at or near 52 week low. The best time to buy these companies are when they show up on the 52 week low list.
• The more investments you can make the greater your chances of buying the one.
• Small bets. The smaller the bets, the more diversification you can have. Remember that with Pier 1, $500 became $50,000. A small bet can turn from a seed to a massive sequoia tree. Do not keep buying more shares of a company that’s on its way to bankruptcy. Make a small bet, and let it ride. If you keep buying more shares of a company that keeps falling, and eventually goes bankrupt, those shares are worthless and you have ruined your diversification.
• Nerves of steal. It’s impossible to call a bottom. So, be prepared for many of these investments to drop more than 50% before they rebound. Just watch and don’t take action. Or, don’t watch! If you can place your bets and check back five years later, even better.

The Bankrupt Mall Basket Once again let me stress that small bets, diversification, and time are absolutely key here. If you don’t have those three things, don’t touch any of these companies. dELIaS (DLIA)  *New addition to basket on 8/20/2014* Burning through cash. Had 28 million in 2011 and now only 3 million. Had zero debt in 2011, now has 14 million. This company is getting killed, which is why it only has a market cap of 31 million. Their CFO, David Dick just left. Launched in 1993 by two Yale graduates, but then quickly sold a decade later to Alloy Inc. for 50 million. It resonated with the Gen Y teenage girls. Can it ever come back? Throw pocket change at this one because of their terrible balance sheet. But, if it ever gets back to it’s 52 week high, it’s a 3 bagger. *DEC 7 2014 UPDATE*, DELiaS declares bankruptcy. Pacific Sunwear (PSUN).  California-themed clothing titan founded in 1980. 7 Utah locations, 645 total locations. 137 million market cap. A 2 bagger if it hit’s it’s 52 week high. 27 million in cash and 86 million in long term debt. California-themed clothing is currently out of style. But, it was in style in the 80s, came back again in the 2000s, and it will come back again. Quiksilver, Inc. (ZQK). You may know them as Quicksilver, Roxy, and DC. These three brands are all owned by the same company. 829 retail stores globally and their products are for sale almost everywhere.  Founded in 1969 Australia. 495 million market cap. A 3 bagger if it reaches it’s 52 week high. 57 million in cash, but almost a billion in debt.  That’s a massive amount of debt.  It has a previously strong action-sports brand with clothes, shoes, and accessories.  Will it come back in fashion? 6/23/2015 update. Down 72% for the basket almost a year later, so I’m doubling down. If it doesn’t go bankrupt, major upside as it will be a 5 bagger if it gets back to it’s current 52 week high. But, lots of debt makes this a high risk.  Aeropostale (ARO). Casual teenage clothing giant since 1973. 992 US stores, and over a hundred global stores. 252 million market cap. A 5 bagger if it reaches it’s 52 week high. 106 million in cash, and ZERO debt. Yes, that’s right, zero debt. This is incredibly important. If I was going to go a little heavier in an investment, it will always be the company with the least amount of debt. How long before Aeropostale becomes fashion forward again? They have the balance sheet to weather the storm. RadioShack (RSH) is dead.  Founded in 1921. Only 61 million in cash, and 600 million in debt. Things are so bad, I can’t think of a way their business will turn around. I did hear a Motley Fool analyst mention that RadioShack basically selling Kickstarter-like projects, inventions from individuals, might work. It definitely ties in with their hobbyist brand. However, my first thought was “Wouldn’t people just buy these from Kickstarter or other Internet websites?”  RadioShack does meet my criteria of brand recognition at bankruptcy prices.  It’s trading for 61 million, which is trading for the cash on its sheet. But, because of it’s massive amount of debt, I’m making a very small bet here. SMALL.  If a miracle happens and it gets back to it’s 52 week high, a 7 bagger. But, the investment is probably going to zero. Throw pocket change at this one just in case it’s the next Pier One. However, selling consumer tech is much harder than furniture. Furniture doesn’t become obsolete.*FEB 5 2015 UPDATE* Radioshack declares bankruptcy.  I’ll be updating this article over the years and putting more eggs in my basket as mall brands hit the 52 week low list with a nice 52 week high/low spread. Monty