“If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit.” – Warren Buffet, Chairman’s Letter to Shareholders 1989 (http://www.berkshirehathaway.com/letters/1989.html)
After learning about this style of investing from watching an interview with Buffet, I decided to go out and find some “cigar butts” in the public market place. These were stocks that, at the time I found them, were trading below working capital (Their price is less than their book value per share value).
The two cigar butts that I’d like to talk about are Wendy’s Arby’s Group Inc (WEN), and Citigroup Inc (C).
WEN
Trading at $4.90
Price to book ratio of: 0.94 (meaning it’s underpriced in terms of stockholder equity and should be around $5.20)
Price to sales ratio of: .60
Revenue per share: $8.16
EPS: -.01
I was really excited when I found this stock because I finally understood what Buffet was talking about. I kept thinking to myself… if this company can get it’s act together and get out of the red, then the stock price is going to go up. For some reason, I think it’s very logical that within the next year to two years, the management will figure out how to improve their position (by selling Arbys, as they just did and made the seller take on some of their debt).
Even if the stock only increases $1.10, that’s a 22 percent return on my investment. That’s hella lot better than what most mutual fund traders get. Think about what the returns would be like if it went up more. Even if I had to wait 4 years for the company to improve to $10 a share, that’s 20 percent a year which is pretty damn good.
The problem is… this is a cigar butt stock and nothing is certain. The reason it’s a cigar butt is because it’s a bad company. As warren says,
Time is the friend of the wonderful business, the enemy of the mediocre
With an increasingly competitive market place (mcdonalds, burger king, other fast foods like taco bell and pizza hutt), the future of this company is in no ways going to be an easy ride. What’s promising is that they are looking to expand more overseas and are introducing breakfast to their menu to match their competitors.
Personally, I think it’s certainly a bargain purchase, but I’m also certain that it’s a cheap-quality purchase too. Maybe there will be a “hiccup” in the fortunes of the business. I kind of think there will be. I don’t have enough money to invest right now, so this is my post that I can go back to and say….”I TOLD YOU SO”…. or, when I’m wrong, feel wiser for not investing.
For you econ nerds out there, if there is such a hiccup, then the efficient market hypothesis is definitely a lie. However, I think Buffet already demonstrated the rewards that our society grants to people that can spot underpriced and undervalued securities.
C
Trading at: 37.63
Price to book ratio: .65
Price to sales ratio: 1.81
Revenue per share: 21.15
EPS: 3.06
Cash per share: 268.17
Book value per share: 58.46
Liabilities: 1.7 B
Longterm Investments: 1.2 billion
Interest expense: 25 million
This company is not in the red. It is profitable!! I included more statistics because I think it gives a better picture of this company’s financial health. This stock is also trading below working capital. A large portion of this company’s assets come from their long term investments. True, they have a lot of debt, but the interest expense is not all-consuming. This is a company that made a horrible business decision, but from reading their annual report, I think it’s mostly fear that’s keeping investors away. Fear about these new regulations and whether or not this company can remain competitive.
Personally, I think this company has proven that it can work (even though it may have made bad decisions in the past). It’s profitable now for godsakes. In the long run, the debt will diminish, the economy will pick up, and the assets will grow, and all the cash they have on hand will be used to fund projects, which will add to the value of the company. They have $268 worth of cash on hand per share and their shares are trading for $38! That’s NUTS. Keep in mind, this is in the long term (think 3 years).
Before the financial crisis, their stock was trading at $550 per share, and it had been trading that high for about 8 years. 8 years!!!! It’s mind boggling. If citigroup recovers to only half of their original value, whoever invests now would be making about 7 times what they initially invested or a 624 % profit. Spread that over a number of years, and you’ve still gotten a really good return. Even if it takes six years, that’s 100 percent a year return. Hell, even if it only returns to a quarter of it’s original value, it’s still a 260% profit.
This is another bargain stock, but, personally, I think it is much better positioned to do well in the long run.
I welcome all comments or arguments against my claims. I realize this is one perspective on the market and by no means the only or right one.
So…this is Cigar Butt investing… making money off underpriced bargain securities when the market re-evaluates them at a higher price. Obviously, if you’re wrong, you have a lot to lose. If you’re not wrong… well…. I guess there’s a reason why Warren Buffet if Warren Buffet.
I’d like to say one final thing…. This type of investing is how Buffet started out, but down the road when he was wiser and more knowledgeable, he denounced this type of investing.
“Unless you are a liquidator, that kind of approach to buying
businesses is foolish. First, the original “bargain” price
probably will not turn out to be such a steal after all. In a
difficult business, no sooner is one problem solved than another
surfaces – never is there just one cockroach in the kitchen.
Second, any initial advantage you secure will be quickly eroded
by the low return that the business earns. For example, if you
buy a business for $8 million that can be sold or liquidated for
$10 million and promptly take either course, you can realize a
high return. But the investment will disappoint if the business
is sold for $10 million in ten years and in the interim has
annually earned and distributed only a few percent on cost. Time
is the friend of the wonderful business, the enemy of the
mediocre.
You might think this principle is obvious, but I had to
learn it the hard way – in fact, I had to learn it several times
over. Shortly after purchasing Berkshire, I acquired a Baltimore
department store, Hochschild Kohn, buying through a company
called Diversified Retailing that later merged with Berkshire. I
bought at a substantial discount from book value, the people were
first-class, and the deal included some extras – unrecorded real
estate values and a significant LIFO inventory cushion. How could
I miss? So-o-o – three years later I was lucky to sell the
business for about what I had paid. After ending our corporate
marriage to Hochschild Kohn, I had memories like those of the
husband in the country song, “My Wife Ran Away With My Best
Friend and I Still Miss Him a Lot.”
I could give you other personal examples of “bargain-
purchase” folly but I’m sure you get the picture: It’s far
better to buy a wonderful company at a fair price than a fair
company at a wonderful price. Charlie understood this early; I
was a slow learner. But now, when buying companies or common
stocks, we look for first-class businesses accompanied by first-
class managements.”
Well… it’s up to you. Just take note, that it seems like he is talking about security purchasing on large scale here (business ownership).
The Thought Hole 