Volume 7, Issue 4
Founded in 1995, Daruma Capital Management invests in high-conviction portfolios of no more than 35 stocks.
Our annualized Small-Cap return net of fees is 13.43% vs. 9.03% for the Russell 2000 since inception (7/28/95 to 3/31/14).
Our annualized SMid-Cap performance net of fees is 12.63% vs. 15.88% for the Russell 2500 since inception (4/30/10 to 3/31/14).
Please read the above performance in conjunction with our Small-Cap Equity and SMid-Cap Equity Composite Presentations. Past performance does not guarantee future results.
For information about our Long/Short strategy, click here.
Today's newsletter features Mark Miller, Daruma Senior Research Analyst.
Mark shares his take on the similarities between pawn shops owners and stock pickers - along with three insights for excelling in either occupation!
(To listen to this month's newsletter, click here
Mariko O. Gordon, CFA
Founder, CEO and CIO
Daruma Capital Management LLC
Pawn Shops, Mobsters and the Search for Value
By Mark Miller, Daruma Senior Research Analyst
My 13-year-old son, Dean, is fascinated with the TV reality show Pawn Stars
. I don't watch much television and I loathe reality shows, but I've been a dad long enough to know that when your teenager asks you to join him in an activity, only a fool would decline. So I agreed.
Much to my surprise, and after watching a few episodes together, I too was hooked. In short, Pawn Stars follows the wheeling and dealing of father and son team Richard "Old Man" Harrison and his progeny, Rick.
Together, along with a couple of amusingly less capable employees, they own and operate the 24-hour a day, Gold & Silver Pawn Shop in Las Vegas.
The pawn shop business model is exactly as you'd expect: people come in off the street to sell (or loan) memorabilia in return for hard cash. The range of goods brought into the shop is remarkably diverse and each item (and its owner) has a story.
Rick has been around the block a time or two and is the house expert (they call him "The Spotter"). He seems to know something about everything - from antique rifles, to high-end motorcycles, to items salvaged from warships. To me, the highlight of each show is the haggling.
The margin between bid and ask is usually quite wide, and the seller almost always arrives with a great story with which to plead his case.
In one episode, for example, the would be seller claimed that the ring in his possession (gold, with a devil's face and ruby eyes) was once owned and worn by infamous mobster, Lucky Luciano. Did he have any documentation? A photo of Luciano wearing the ring? Nope. Just a story about how his mother came into possession of the item thanks to her "close ties to the underworld."
In the end, and after Rick brought in an expert from The Mob Museum for a second opinion, the Harrison team remained unconvinced and declined to make an offer. Most of the time, the decision is a more difficult call, but rarely do you see a guy throw his mom under the bus for a few bucks. What's been most striking to me over the past few months is how similar the pawn shop business is to our own as stock pickers
(and I'm not just talking about the colorful characters we both get to meet, either). In practice, we rely on many of the same rules of thumb
, even though we operate at decidedly different ends of the street. Specifically:
- Do your homework. Old Man and Rick prosper because they know and understand the marketplace; their knowledge of the unusual (and its street value) is striking. And, when they don't know something, they do whatever research is required before making a bid. Rick has received expert consultation on handwriting, 15th century manuscripts, sports memorabilia, and dozens of other areas.
As investors, we're similarly in need of up-to-date, accurate information. At Daruma, that involves first-hand, on-site research, interviews with those whose opinions we respect and an eagerness to leverage the knowledge and experience of our internal team, to make sure we've turned over every possibility.
- Minimize the downside. Like stock pickers, the Pawn Shop boys are also on the hunt for the ten baggers. Was this sword really owned by Robert E. Lee? Is this, in fact, the dress worn by Zsa Zsa Gabor at her fifth wedding? If the answer is "yes," they win big. But if it's "no," and they end up in possession of a cheap souvenir, they want to make sure they haven't paid much more than the item's real value.
As investors we want the big wins too. But, as the founder of Investor Business Daily, William O'Neil, once observed, "The whole secret to winning and losing in the stock market is to lose the least amount possible when you're not right." For us that means buying at a price that considers the risk and that is based on business fundamentals, in case "the story" of the stock in question turns out to be overly optimistic.
- Don't get emotionally attached. The people who show up to trade their goods for cash are excited. Not only do they arrive with a good story in hand, they often have a personal attachment to the item in question. That often clouds their thinking, leading them to expect more for whatever it is they're trading than it's really worth.
The shop owners feel none of that. They're detached, objective, willing to walk away. To them, all that matters is the value. And while they may occasionally pay a little more for something that they themselves find intriguing (they seem to like vehicles), it's always done with eyes wide open.
It's easy to get emotionally attached to a stock as well. Maybe you like the story. Maybe you admire the executive team. Maybe you've held it so long and done so well that you're reluctant to let it go. Whatever the reason, once your emotions start driving the process you're setting yourself up for a bad decision.
So let's give some credit to the talented "pickers of stock" (if not stocks) at Gold & Silver Pawn Shop, whose business isn't that different from ours.
And, while we're at it, let's chalk one up for my son, too. He reeled me in with an offer to watch "some History Channel programming," a story which, while true, was nothing like I had imagined.