The Sears Mistake

by: Nadav Manham November 12, 2008 | about stocks: BRK.A / BRK.B / SHLD    

Nadav Manham

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I'm a big Edward Lampert fan, but Sears is not doing well.

I'm convinced it was a big mistake for Lampert to spend $5bn of Sears' cash on stock repurchases.  Not a mistake in hindsight, but in foresight:  At the time he shouldn't have done it, and should have known not to do it.  And I don't think this simply because the stock has declined since then.

Our mutual idol Warren Buffett is famous for his advocacy of share repurchases.  He's also famous for stating that an investor should practice diversification only as a protection against ignorance -- if you know what you're doing then it's better to put all your eggs in one basket and watch that basket.  By both counts, Lampert was doing as our idol advises when he bought back Sears stock -- the value of which made up a large proportion of his and ESL's net worth -- rather than paying out that cash as dividends, investing it elsewhere, or simply holding onto it.

But I must point out that for all his advocacy, in over 40 years Buffett has never repurchased a single share of his own company's stock, preferring instead to accumulate almost $50 billion of cash at its peak.  And I must also point out that Berskhire Hathaway (BRK.A) is among the most diversified corporations ever assembled.  So the conventional wisdom about Buffett is wrong, or at least has its limits.  Buffett himself admitted as such in a little-known sentence from the 1980 Letter to Shareholders:

We, of course, have a corporate policy of reinvesting
earnings for growth, diversity and strength . . .

 

Of the three stated goals, we're all most familiar with how successful the growth part has been.  But don't forget how successful he's been on the other two as well. 

By committed so much money to repurchasing Sears shares, Lampert was going for (per share) growth, but neglecting diversity and strength.  Sears' remaining shareholders are now more invested in Sears' success than they otherwise would have been (less diversity), and more leveraged as well (less safe). 

You inflict those two strikes on yourself and your shareholders only if you get a lot back in return, and you can get a lot back in return for repurchasing shares only if you buy them at a significant discount to their intrinsic value.  Washington Post shares in the early 1970s counts.  Coca-Cola (KO) shares in the mid 1980s counts.  Sears shares in the past three years, no matter how optimistic you were, were simply not in the same category.

Lampert did an admirable job of milking Sears' assets, and his decision to cut back on capex may yet prove correct, but buying back shares was a mistake.

Disclosure:  Long Berkhire Hathway, no position in Sears.

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This article has 6 comments:

  •  
    Nov 12 06:38 PM

    Lampert learnt one step less than the master Buffett; that is never buy your own share like Buffet never buy Berkshire preferring to hold cash. Interestingly Buffett says "cash is a terrible long term investment" but Berkshire holds ever larger amounts of cold CASH!
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  •  
    Nov 12 11:00 PM
    Warren holds cash when he can't find compelling values - meaning that he will be in a position to take advantage if the market stumbles or a particular company stumbles.

    As to Sears, if Eddie plans to keep it as a retailer, he's running the place into the ground. He's trying to run a retailer like a hedge fund and failing. Ironically, I'm effectively long Sears because of a large investment in the Fairholme fund, which trusts his leadership.
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  •  
    Nov 13 04:39 PM
    Jim Cramer remains "mum" on SHLD. His telephone screeners and producers conveniently shun the people who call in asking for his opinion on this stock that he has revered (and touted) for so long.
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  •  
    Nov 13 04:51 PM
    Not a mistake at all. The intrinsic value of SHLD is way north of any price they'd paid to buy shares. It would've been impossible to predict this downturn to 40 bucks as well. In the end, we might see a VW type squeeze on the shorts as very little public float will be left.
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  •  
    Nov 13 05:41 PM
    Ed Lampert is doing the right thing...you just wait and see. The SHLD is still selling below its underlying value and he's making no mistake by buying those shares back. WEB, on the other hand, is not buying back BRK shares because the market price is still above the tag price he's willing to pay and, besides, he's seeing other great businesses with very attractive tag prices...
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  •  
    Nov 26 07:05 PM
    so jimbo is still in awe of lampert. well i regret not selling the stock at 175 and would have made a nice profit.
    but i was in full belief that he was going to be then next buffett and go to 1k in three years.
    next!!!!!
    or buy, buy buy.................. what do you think???


    On Nov 13 04:39 PM bluehorses wrote:

    > Jim Cramer remains "mum" on SHLD. His telephone screeners and producers
    > conveniently shun the people who call in asking for his opinion on
    > this stock that he has revered (and touted) for so long.
    Reply | Link to Comment
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