Grahamian Value Longform ― September 2, 2020
“One of the things we’ve done – Edwin and I – is hold over a hundred companies in our portfolio. Now Warren [Buffett] has said to me that, that is a defense against stupidity. And my argument was, and I made it to Warren, we can’t project the earnings of these companies, they’re secondary companies, but somewhere along the line some of them will work. Now I can’t tell you which ones, so I buy a hundred of them.”
― Walter Schloss, 2003 (in conversation with Eli Rabinowich)
THE CO-EDITORS’ VIEW
I. FEATURED COMPANY: TANDY LEATHER FACTORY, INC.
Headquartered in Fort Worth, Texas, Tandy Leather Factory, Inc., is a specialty retailer of a broad product line including leather, leatherworking tools, buckles and adornments for belts, leather dyes and finishes, saddle and tack hardware, and do-it-yourself kits. The Company distributes its products through its 108 North American stores located in 40 US states and 6 Canadian provinces, and one International store located in Spain. Select Further Readings – Updated September 1
A PROBLEM YEARS IN THE MAKING
“...Do a REAL audit of the inventory. You might find a surprise.” Yahoo Message Board Post by “Steven” (circa 2018)
NON-RELIANCE ON PRIOR FINANCIAL STATEMENTS
U.S. Securities and Exchange Commission: “…previously issued financial statements included in the Company’s most recent Annual Report on Form 10-K and Quarterly Reports on Form 10-Q should no longer be relied upon, as a result of misstatements primarily relating to the Company’s methods of valuation and expensing of costs of inventory and related issues, which were first identified by management as a result of a deeper analysis of legacy systems and practices that have been in place for many years.” Exhibit 99.1 to 8-K filing – October 21, 2019
A MOTHERLODE OF BACKGROUND (NOTE: PRE-COVID19)
Authored by ‘woop’: “...As TLF resolves the accounting mishaps and reports the missing quarters (Q2 2019 and Q3 2019) and coming quarter (Q4 2019), LTM EBIT is likely to rise to greater than $7M (and perhaps greater than $10M) on a $22M EV stock (assuming, say, $4M of Q4 2019 cash buildup from the current $29M EV) —leading to a 2.0x-3.2x EV/EBIT (if the [then] current $4.82 share price were to persist). That is far too cheap for a high free cash flow business that has survived Amazonization.” Value Investors Club – December 17, 2019
FORCED-SELLING CREATES SPECIAL SITUATION
“We believe that Tandy Leather Factory is currently mispriced due to the indiscriminate selling that has occurred surrounding the potential delisting, where many institutions would not be able to hold the stock and others simply would not want to hold a less liquid, less transparent company. With that said, the indiscriminate selling may not yet be over, as 1) they could be denied an extension by the Nasdaq panel and subsequently delisted; and, 2) if granted the extension, they may not be able to meet their August 10th, 2020 deadline.” Low Tide Investments – March 2, 2020 (twitter)
DELISTED DUE TO MISSED RESTATEMENT DEADLINE
U.S. Securities and Exchange Commission: “…despite herculean efforts from our team under unprecedented circumstances, we were not able to complete our restatement and make the required SEC filings by the August 10 deadline set by Nasdaq. This is a real disappointment to us, but we will continue to push forward to complete these filings as quickly as possible. If we are delisted as we expect, then we intend to promptly apply for re-listing on Nasdaq once the required filings have been made.” Exhibit 99.1 to 8-K filing – August 12, 2020
POTENTIALLY IS (LONG-TERM) STRUCTURALLY FLAWED
Authored by ‘chrisash’: “The Tandy Leather Factory [business] model was great when wages were low [with] lots of home buyers. Now the whole market has changed with the internet; with prices dropping from all around the world, you just cannot [have a] store holding large quantities of slow moving stock sitting on shelves when you can run one major warehouse selling on the internet.” Leatherworker.net – August 12, 2020
WHEN (AND WHEN NOT!) TO AVERAGE DOWN
“At a very big picture: averaging down when you are right is very sweet, averaging down when you are wrong is a disaster... Kodak was made obsolescent and was a value stock all the way down to bankruptcy. The circumstances on which you might be wrong (digital photography going to 95 percent of the market) could have been stated pretty clearly in 1999. You might think it was worth owning Kodak as a ‘cigar butt stock’ - plenty of cash flow and deal with the future later. There was a reasonable buy case for Kodak the whole way down. But technical obsolescence is always a way you could be wrong. When the threat is obsolescence you are not allowed to average down.” John Hempton – January 4, 2017 (twitter)
AUTHOR OF DEAR CHAIRMAN IS TANDY LEATHER FACTORY’S CHAIRMAN
Courtesy of Tobias Carlisle, The Acquirer’s Funds: “[Tandy Leather Factory] was extremely cheap, I went down to meet with the company. I thought they were nice and honest. It seemed like they knew their business… I’m on the board now, and we’re going through an accounting restatement. If you’ve ever gone through an accounting restatement, it’s pure misery.” Jeff Gramm – March 9, 2020 (twitter)
Important: All figures are as originally appeared in respective source articles and dated accordingly. While the co-editors admire the above showcased thought leaders, all opinions expressed are subject to error and intended for educational purposes only.
II. THE CO-EDITORS’ VIEW
A VIEW FROM HARRY SAUERS
Benjamin Graham advocates for buying diversified baskets of net-net stocks: “It always seemed, and still seems, ridiculously simple to say that if one can acquire a diversified group of common stocks at a price less than the applicable net current assets alone… the results should be quite satisfactory.” (The Intelligent Investor, Fourth Revised Edition, page 391)
Graham reasoned that ownership of a group of stocks, purchased at an appropriately low price, if one could eliminate company-specific risk, would likely make a profit.
My own journey as an investor began with (very) concentrated portfolio weightings; it seemed logical to only allocate capital to my best ideas and to calibrate based on confidence. I quickly learned, however, that this wouldn’t work very well for a portfolio of “bargain issues” – equities with underlying businesses typically subject to more idiosyncratic risk than larger (and safer) enterprises. Investing in any single extraordinarily cheap company may not be a sound investment decision. However, as a group, such equities can present a compelling opportunity.
Due to the heightened level of company-specific risk among exceptionally cheap equities, I’ve found that I’m not skilled at separating my winners from my losers ahead of time. Rather, I embrace that a broad (and diversified) portfolio of cheap stocks is expected to deliver a reasonable return. Accordingly, an equal-weighting towards each position best allows me to take full advantage of the collective statistical cheapness. Equal-weighting (in a diversified portfolio) protects an investor from ignorance (or bad luck) on any single company, reduces the chance of human bias, and provides better exposure to the systematic-trend of cheap stocks providing satisfactory returns.
Tandy Leather Factory is a fitting example of the above analytical framework; it’s notably cheap, yet an outsized position size is imprudent for a multitude of reasons.
Risks and Uncertainties Abound
The retail shoe industry faced limited disruption in the early days of e-commerce. Intuitively, wouldn’t most consumers prefer to see, hold, and try-on a physical shoe before committing to a purchase? Tony Hsieh and Zappos (and Amazon, beginning in 2009) have shown us that it’s short-sighted to bet against long-term creative disruption in the age of the internet.
Tandy Leather Factory’s sales and customer base have (so far) proven largely immune to the “Amazon effect” — the company’s niche market and well-regarded brand have (again, so far) fared well. The relentless growth of Amazon (and e-commerce, more broadly) pose an existential threat to Tandy Leather Factory’s core business: leather may prove to be just like shoes, at some point. All that said, for the moment Tandy Leather Factory seems to be doing reasonably well: sales for the month of July are only down 5% relative to the same period in 2019. Of particular note and with emphasis added, Tandy Leather Factory updated on August 10, “If there is a silver lining to this [COVID-19] crisis for our business, it has been that our web sales since closing our stores are up 160% versus last year.”
Tandy Leather Factory’s publicly-listed equity is subject to unique uncertainty: The lack of current financials (other than sales and cash) limits one’s ability to confidently arrive at a current valuation; Tandy Leather Factory’s net current asset value is unknown.
Tandy Leather Factory’s inventory was carried at $30.6 million as of the most recently filed 10-Q, dated May 10, 2019. Once restated, impaired, and/or sold, it’s very possible that inventory may be worth quite a bit less than $30.6 million. At the same time, Tandy Leather Factory owns the 22,000 square foot building that houses the company’s flagship store in Fort Worth, Texas opened in 2013. Further, the company owns its corporate headquarters, which includes a central distribution center and manufacturing facility, sales, marketing, administrative, and executive offices. The facility consists of 191,000 square feet located on approximately 30 acres. In our view, Tandy Leather Factory appears to be valued in-line with cash plus owned property, thereby assigning inventory negligible (and possibly, negative) value.
A Potential Cannibal
Tandy Leather Factory’s present market capitalization is roughly $25 million and the company’s board of directors approved a $5 million share repurchase program on August 10. With emphasis added, “the Company will be able to resume share repurchases in the open market following completion of the Company’s financial restatement and making all required periodic filings with the SEC.” Of note, Tandy Leather Factory repurchased 4.7% of outstanding shares in the midst of 2009’s equity market and economic turmoil.
“Diversification is a Hedge Against Ignorance”
Personally, Tandy Leather Factory’s stock appears compellingly cheap — as best as can be ascertained with limited information. I remain (cautiously) optimistic that over a multi-year horizon “darkest before dawn” is more likely than “darkest before impact.” While the latter is certainly possible, I have confidence in the Board of Directors and the margin of safety afforded by the company’s cash and real estate.
While uncomfortable making a single-name investment in Tandy Leather Factory due to the many aforementioned risks and uncertainties, I am attracted to the broader, statistical exposure of the equity; its sheer valuation makes it an intriguing candidate as a component within a diversified portfolio of similarly cheap stocks. With this basket approach, diversification is a deliberate hedge against known ignorance. Doing so requires confidence in the statistical-advantages of buying something for less than it is worth, and a willingness to self-acknowledge and self-accept when one is uncertain of how any single investment will (or will not!) work out.
III. PLATFORM UPDATES
The astute Grahamian Value reader will notice that the number of Hong Kong stocks listed on GrahamianValue.com has decreased (substantially) since our prior update.
We are opting for a more selective approach, reflecting a desire to err on the side of prudence and conservatism (and we hope, integrity). Until we have a better solution: this winnowing process is done mechanically using the Beneish M-Score, a statistical model used to identify earnings manipulation on financial statements.
While the Beneish M-Score will certainly not catch every company that bears serious governance risk, we hope that this blunt-force tool will lead to an output that is slightly better distilled than our prior iteration. We strongly emphasize, regarding Hong Kong and anywhere else, that a “buyer beware” approach is necessary. Please also remain aware that while GrahamianValue.com reflects an ongoing best effort, it surely contains (many) errors and is intended for general informational purposes only. We welcome your corrections and comments, please contact us at email@example.com
From the other side of the world, we look towards the work of David Webb for (much needed!) local guidance within the Hong Kong stock market. Mr. Webb’s contributions to the state of local intelligent investing in Hong Kong provide us with inspiration in our ongoing journey as we endeavor to navigate through the depths of Graham-inspired value around the world.
In Recognition of David Webb
David Webb is a retired investment banker and activist in Hong Kong. As noted by Forbes, he “... has done more to advance corporate governance in Hong Kong than any one person.” Mr. Webb has pushed for governance reform in Hong Kong and beyond, investigated fraudulent or shady companies, and maintained a free and publicly-available “not to own” list of stocks.
On June 8, Mr. Webb stated that his vast body of research will enter a “sporadic, semi-dormant” phase of maintenance; he is seeking a permanent home for his 22-year treasure trove of wisdom that allows for continued free and public access.
Webb’s Remarkable Record of Success
As far as past returns go, Mr. Webb has achieved an impressive track record: estimated at a compound return of 20% per year for over two decades, while the Hang Seng index returned just over 8% annualized. Mr. Webb primarily invests in Hong Kong-based small caps, where local markets typically apply a valuation discount — in large part due to a “lemon discount” on poor governance.
His “not to own” list of stocks have lost an aggregate US $16 billion in market value. Similarly, his research has spurred a number of law enforcement raids against miscreant corporations in Hong Kong.
Mr. Webb has sent over one thousand letters to various securities exchanges and regulators, and sat on the board of Hong Kong Exchanges & Clearing Limited. In this role, Mr. Webb has pushed for stronger governance and greater protections for minority shareholders.
Diving Deeper at Webb-Site.com
Webb still runs “Webb-site Reports” where his research and commentary is freely available. His current disclosed investments can be viewed here. Webb’s “not to own” list (also called the “Enigma Network”) can be found here.
IV. FURTHER RESOURCES
WHY DOES AN EQUAL-WEIGHTED PORTFOLIO OUTPERFORM VALUE- AND PRICE-WEIGHTED PORTFOLIOS?
Why Does an Equal-Weighted Portfolio Outperform Value- and Price-Weighted Portfolios: “We find that the equal-weighted portfolio with monthly rebalancing outperforms the value- and price-weighted portfolios in terms of total mean return, four factor alpha, Sharpe ratio, and certainty-equivalent return, even though the equal-weighted portfolio has greater portfolio risk. The total return of the equal-weighted portfolio exceeds that of the value- and price-weighted because the equal-weighted portfolio has both a higher return for bearing systematic risk and a higher alpha measured using the four-factor model.” Yuliya Plyakha, Raman Uppal, and Grigory Vilkov – 2012
VALUE-WEIGHTED INDEX - A NEW APPROACH TO LONG-TERM INVESTING
ValueWeightedIndex.com: “The problem is that market-cap weighted indexes increase the amount they own of a particular company as that company’s stock price increases. As a company’s stock falls, its market capitalization falls and a market cap-weighted index will automatically own less of that company. However, over the short term, stock prices can often be affected by emotion. A market index that bases its investment weights solely on market capitalization (and therefore market price) will systematically invest too much in stocks when they are overpriced and too little in stocks when they are priced at bargain levels.” Joel Greenblatt
GRAHAM–NEWMAN LETTERS TO PARTNERS
Graham-Newman Corporation Letter to Stockholders: “The current Prospectus of the Corporation states that its general investment policy is… To purchase securities at prices less than their intrinsic value as determined by careful analysis, with particular emphasis on purchase of securities at less than their liquidating value.” Benjamin Graham and Jerome Newman – 1946 (more: all years)
NET CURRENT ASSET VALUE STOCKS IN LONDON
Testing Benjamin Graham’s Net Current Asset Value Strategy in London: “It is widely recognized that value strategies - those that invest in stocks with low market values relative to measures of their fundamentals (e.g. low prices relative to earnings, dividends, book assets and cash flows) - tend to show higher returns… we observe that those with an NCAV/MV [market value] greater than 1.5 display significantly positive market-adjusted returns (annualized return up to 19.7% per year).” Ying Xiao and Glen Arnold – 2007
THE PITFALLS OF NET-NET INVESTING
“Net-Net investing can be very rewarding. The academic backtests show strong annual returns that trounce the market. But in the real world, investing is messy. Take a look at Keytronic Corporation for example. We had written about them earlier this year (KTCC)…” Nothing But Net-Nets – August 8 (twitter)
ABOUT GRAHAMIAN VALUE
Grahamian Value is a labor of love, centered around our desire to openly share data and perspectives that we find helpful in our pursuit of Benjamin Graham-inspired investment ideas. We appreciate your time, your trust and your readership. Learn more at GrahamianValue.com
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Harry Sauers and Shai Dardashti are co-editors of Grahamian Value and, as of the date of this communication, individually own shares of Tandy Leather Factory, Inc. This communication is for informational purposes only. This is not intended to be investment advice. Seek a duly licensed professional for investment advice.