Don't Over Bet on the Jockey

 | Jul 17, 2012 | 3:30 PM EDT  | Comments
  • Comment
  • Print Print
  • Print
Stock quotes in this article:

shld

,

ko

,

BRKA

Without question, the unparalleled appreciation in the value of Berkshire Hathaway (BRK.A) stock over the past 40-plus years has been a direct result of Warren Buffett's leadership. It's also true that the loyalty of longtime Berkshire investors is directly connected to Mr. Buffett.

The success and lore of Berkshire Hathaway has led many investors to make investment decisions based on the premise of betting on "the jockey instead of the horse." Find a so-so business (such as a textile mill called Berkshire Hathaway back in the 1960s), put in the hands of an A+ plus leader and that so-so business will turn into a remarkable company. If only it were that simple. The reality is that over reliance on the jockey part of the equation leads to poor investment decisions.

The simple solution? Do not over bet on the jockey. In financial parlance, in most instances, investors should avoid paying a premium for management because in most instances a management premium is unwarranted. Consider a great example today: retailer Sears Holdings (SHLD). Sears, in its present form, is the work of investment whiz Edward Lampert who brought K-Mart out of bankruptcy and combined it with Sears to create Sears Holdings. Shortly after the combination, shares in SHLD traded for nearly $200 a share. Since then, continued poor retailing performance has led to a share price decline of more than 70%. Longtime investors in Sears who bet on Lampert (assuming they haven't sold the stock) have experienced a painful journey.

The over reliance on the jockey blinded investors to a very simple, yet important fact: retailing is a very tough, competitive industry that is a mediocre business at best for the vast majority of retailers. Of course, good management is important to any company but ironically Buffett said it best when he remarked that the best businesses are those than can be run by a monkey because one they may might. If you think about Buffett's most successful investments, they have been companies that he's held for decades who have been led by numerous CEOs. And they are inherently excellent businesses like Coca-Cola (KO), Gillette, Wells Fargo (WFC), American Express (AXP), and most recently IBM (IBM). One of the best jockey's himself doesn't bet on many jockeys.

I have cited retailer J.C. Penney (JCP) as an interesting stock now that Bill Ackman is in control. The company is now arguably led by the one the best retailing executives in the business, Ron Johnson, who cut his teeth at Target (TGT) and then came to Apple (AAPL) and turned it into the most profitable retailer on the planet. The natural tendency is to assume that with such a brilliant management team, it is only a matter of time before JCP becomes an investment success. The shares are trading for $19, a new 52-week low. To be sure, at this price, the investment is very interesting from a pure value perspective, but you have to be able to ascertain the value of the retailing operations. If you can buy a stock for a cheap price and get excellent management for free, that's a very interesting proposition. But J.C. Penney's future is uncertain in today's retailing environment because it is caught between names such as Target and the dozens of other mall-based department stores.

So keep in mind that simply investing based on the jockey, regardless of his or her previous track record, can be a very expensive mistake when you don't account for the underlying economics of the business.

Columnist Conversations

I set you up for the trading Week Ahead from the floor of the NYSE with Peter Costa of Empire Executions... Ha...
LNKD is trading $226.08, up 3.1% with IV30™ up 0.4%. This is a stock price and volatility note on a so...
From Moody's: "Dynegy announced that it expects to finance the transaction with $5 billion of unsecured notes ...
Kohl's is beginning to lose its upside momentum this week. The stock has been in hyper drive since the ...

BEST IDEAS

REAL MONEY'S BEST IDEAS

Columnist Tweets

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.