The web is littered with lists, boasts from every corner, each claiming to be the penultimate collection of tips, tricks, lessons, and laws. Smart investment is driven by experience and data, and you often have to navigate through the digital debris to find good advice. But mistakes are just as instructive. Smart people are never entirely immune to bad judgment. So we are offering a new monthly series—My Best, My Worst, My Next—which offers three personal anecdotes from world-class investors. We hope to guide you towards success, warn you away from failure, and provide an advanced peek at the future.
Confused by market-timing gurus divided over whether we are in for a major correction or the bull has further to run? Value investor Ian Lapey, a protégé of legendary investor Marty Whitman and co-manager of Whitman’s flagship Third Avenue Value Fund, looks solely at company balance sheets. Here are his best, worst and next picks.
MY BEST: Tripling the Money
Cimarex Energy, (XEC), a Denver-based oil and gas exploration and production company, was just the kind of investment they like at Third Avenue—safe and cheap. The company used no leverage, yet its net asset value had been growing by double digits. Lapey first learned of the company’s sound financials and the conservative, long-term outlook of its debt-averse chief executive, F.H. Merelli, back in 2004. But he waited to buy till 2007, when Cimarex was trading in the low $30s, at a slight discount to net asset value.
Good timing. The financial crisis of 2008, and the plunge in oil and gas prices it brought, validated Lapey’s approach. Cash-rich Cimarex was able to pick up valuable acreage on the cheap from its financially strained competitor, Chesapeake Energy Corp.
Earlier this year, when Cimarex traded in the low $100s, Third Avenue sold its stake, tripling its money.
The rationale for selling? Cimarex stock rose at a rate of 30%, while the net asset value appreciated at about a 15% rate over the same period. “We would love to be shareholders again one day,” Lapey says.
When the price is right, that is.
MY WORST : The Day the Music Died
Handleman Co. (HDLM) seemed like a good find when Third Avenue Value invested in the company in the mid-2000s, with the shares trading at $12. Lapey liked the stock, which was trading near tangible book value. Handleman had historically strong free cash flow, and the management team was repurchasing a lot of stock. Also reassuring: The company was a category distributor for Wal-Mart, a partnership that generated 70% of Handleman’s sales. There was just one problem. The category in which Handleman operated was distribution of CDs.
Even though the threat from digital music distribution already loomed, Handleman was gaining market share. Lapey figured that with Wal-Mart as a client, the potential for more cash flow was still there. But the music industry went digital faster than Lapey had expected.
To make matters worse, Handleman soon weakened its balance sheet when it bought Crave Entertainment, a videogame software distributor, which turned out to be a money-losing operation, says Lapey. He became alarmed when Handleman had to refinance its debt on worse terms. He worked with the board on management changes, but to no avail. Third Avenue Value sold the stock in late 2008 for about a dollar a share, losing 90% of the investment. Today Handleman, which has avoided bankruptcy, trades at 10 cents.
“It was a terrific learning experience for me,” says Lapey. “Never buy a company whose industry is in secular decline.”
MY NEXT : One-Upping Warren Buffett?
Lapey’s latest big investment harks to his past, when he was a sell-side analyst at Credit Suisse First Boston, following the housing industry. That’s when he met Joseph Stegmayer, an executive at Clayton Homes, a company that was eventually purchased by Berkshire Hathaway. Lapey kept in touch with Stegmayer over the years, and Third Avenue invested in Cavco, (CVCO), a builder of manufactured and modular homes, where Stegmayer became chief executive.
When another home builder, Fleetwood Enterprises, filed for bankruptcy in 2009, Third Avenue Value and Cavco partnered 50/50 to buy the manufactured-home assets of Fleetwood for $26 million, creating Fleetwood Homes. In 2010 a larger competitor, Palm Harbor, declared bankruptcy: Third Avenue Value and Cavco snapped up its assets for Fleetwood Homes for $84 million. With a 15% market share, Fleetwood Homes is now the second-largest manufactured-home builder in the nation after Berkshire Hathaway’s Clayton Homes, which has some 50% of the market.
Stegmayer has managed to run Cavco profitably amid the worst market for manufactured homes in 40 years, says Lapey, who is counting on even better long-term returns.
And one more thing. “We have created the number two player in the industry next to Berkshire Hathaway’s Clayton Homes at a price of $110 million,” Lapey remarks with just a hint of a smile, “while Berkshire paid $1.7 billion for Clayton.”