"Lethargy bordering on sloth remains the cornerstone of our investment style." -- Warren Buffett, 1990 Chairman's Letter to shareholders of Berkshire Hathaway
I like buying small companies with a long growth runway, dedicated and involved leaders, buying at a discount to my perception of fair value, holding for the long term, and periodically adding shares at opportune prices. I embrace "lethargy with every stock purchase, vowing to do nothing unless a game-changing thesis-breaker arrives. If chosen well and left alone, the gains can be very satisfactory. My two largest individual stocks Portfolio Recovery Associates � (NASDAQ: PRAA ) and Biglari Holdings (NYSE: BH ) �-- each roughly 10% of my portfolio -- have both reached such status by being bought well and then left alone. Each offers lessons for investors today.
Giving debt collection a good name
Portfolio Recovery buys defaulted consumer debt from credit card providers such as MasterCard, Visa, and Discover; it also collects bankruptcy paper and has acquired a diversifying set of fee-for-service businesses in such exciting industries as back tax collection, class action lawsuit collections, and auto-loan collateral tracking (skip-tracing). It buys debt for pennies on the (face value) dollar and then turns that debt over to its collector workforce, which collects two to three times the purchase price over the next seven years.
Simple, right? The reality is that it requires experience to appropriately value debt, discipline to purchase the debt at reasonable prices, and well-trained collectors to work the paper. Overpaying is akin to burning money, and excellent pricing models are of questionable use if the collector can't cajole debtors to pony up. Fortunately, disciplined pricing and collection has long been Portfolio Recovery's strength.
This is a "knowledge business," and thus Portfolio Recovery is heavily reliant on the expertise of its management. Fortunately, they're a gold standard team, led by co-founders CEO Steve Fredrickson, and CFO Kevin Stevenson after the pair did similar work at a division of HSBC. Attractive about Portfolio's management is what they don't do. They don't provide earnings guidance or try to manage investors' expectations. They don't sacrifice long-term shareholder value for near-term reported earnings. They don't get fancy perks like country club memberships, cars, or corporate jets, and the company eschews option compensation in favor of modest restricted stock grants. Senior executives are required to own stock alongside common shareholders.
Over the years, management has diversified its revenue: adding and aggressively ramping up unsecured bankruptcy account collections, legal collections on debtors identified as "can-pay-but-won't-pay," and controlled expenses to maintain profitability. I first purchased shares of Portfolio in 2004. Since then the steady hand of management has increased cash collections, revenues, and earnings 25%, 23%, and 20% annually, respectively.
And because there's no shortage of debt, and thus charged off debt, Portfolio's growth still has a long runway. I've added shares over the years based on a quick valuation heuristic I developed. My method compares the company's adjusted enterprise value (market capitalization plus net debt, less an estimate of value for the owned fee-for-service businesses) to the expected remaining collections on owned portfolios (available in each quarterly report) after all cash expenses are paid. A number below 1.00 signals a company arguably being valued as worth more dead than alive, but this mispricing level is rarely seen (and should be exploited when it is seen). My valuation ratio currently sits at 1.56, which is decent, but I do tend to prefer to add below 1.30, which would require a stock price today around $100.
This is a quality company doing good things. Buy shares and add at advantageous prices, and then leave it alone to do its work.�
Would you like fries with that?
My second large holding is, in many ways, similar -- at least in the way it came into, and subsequently grew, in my portfolio.� In other ways, it is dramatically dissimilar. Biglari Holdings is the holding company run by Sardar Biglari. If you don't readily recognize the name, it's because the public listing was previously known as Midwestern iconic burger brand Steak 'n Shake. Sardar Biglari started getting noticed in 2006 after first gaining control of restaurant chain Western Sizzlin, then forcing second target Friendly Ice Cream into the embrace of private equity. His subsequent quest for board representation at Steak 'n Shake culminated in his eventual appointment as chairman and CEO in mid-2008.
I acquired most of my stake at this time at split-adjusted prices between $100 and $150 per share. Those were heady times as Biglari was drawing accolades as a "next Buffett." Since then though, the cheering has muted. Certainly, Biglari oversaw a commendable turnaround at Steak 'n Shake, converting the restaurateur into a cash-producing machine. However, later moves -- including renaming the firm in his own image, consolidating�his other business interests under this new corporate structure, and implementing a new, generous, compensation scheme arguably somewhat misaligned with outside shareholders --�have induced howls of betrayal from many who previously heaped praise.
I like Biglari as a capital allocator with an eye for underperforming companies and a dogged determination to pester his targets into exasperated value creation -- often through a corporate sale. His current target is Cracker Barrel Old Country Store (NASDAQ: CBRL ) , where Biglari is the largest shareholder owning nearly 20% of the shares, and has already fought two proxy battles where he may have technically lost the vote, but he's been rewarded by the company adopting many of his operational strategies to keep him at bay. The Cracker Barrel stake is worth $371 million, or more than half of Biglari Holdings' $668 million enterprise value.�
The value of inactivity
I envision doing nothing with my Portfolio Recovery stock for a long time to come and would happily add shares at attractive prices. On the other hand, I'm not likely looking for additional Biglari shares unless the price is very low. Unlike Portfolio Recovery management, who have a long history of sticking to their knitting, Biglari, who has repeatedly referenced the company as a "jockey stock," has provided evidence that he'll look out for the jockey first and foremost. Given the jockey's proclivity for self-enrichment, I'll sell when I perceive the stock has run past intrinsic value, which represents a price above $480 today.
That said, both Portfolio and Biglari are fine examples of the benefits of purchasing stocks on the cheap, and leaving them alone to let compounding work its magic. This type of stock ownership "lethargy" can also be found in Motley Fool One, where Motley Fool Tom Gardner's Everlasting Portfolio owns companies for a minimum of five years; ideally for much longer. You can check out his top two stocks that meet his criteria. To find out all about them;�just click here to check out Tom's picks right now.
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