What Would Your Replacement Do?
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
One of the fatal flaws of most investors is anchoring on a mindset. Whether it is not buying a stock because it is a few percentage points higher than our desired buy price or not selling a stock because it’s below our breakeven price, investors tend to make too many decisions with our hearts and not our heads. Sometimes it pays to take a step back from your business or an investment and look at it as if you were an outsider.
Take for example the famous story of Intel (NASDAQ: INTC) back in the late 1980’s. Back then Japanese companies were able to make memory chips cheaper and better than everyone else and it was putting many companies out of business. For Intel though, they were anchored to the business until one day Andy Grove turned to Intel co-founder Gordon Moore and said, “what would happen if somebody took us over, got rid of us – what would the new guy do?” Without much hesitation Moore said, “Get us out of the memory business.” However, instead of just leaving it at that they set out a plan to get Intel out of the memory business which then set them up to be ready when opportunity arose in the form of the personal computer revolution.
Sometimes the problem at a company isn’t in holding on to a division that should be let go, but it is in rapid expansion that sometimes is referred to as empire building. You tend to see this a lot in the retail or restaurant industry where a company will expand as fast as it can in order to get big. While scale can indeed be a competitive advantage, if it’s done simply to increase the size of the company, it can be a disadvantage. The shopping centers of America are littered with the empty store fronts from companies who tried to expand for expansion's sake only to have to close down under performing locations a few years later. In 2012 Abercrombie & Fitch (NYSE: ANF) for example, announced they were closing 180 stores by 2015 which is on top of the 71 stores closed last year further on top of the 64 closed in 2010. On a base of just over 1,000 stores it represents closing nearly 30% of the store base. While A&F has continued to open stores, it does beg the question of whether or not their expansion has been too rapid and if shareholders would've been better served by simply returning their capital to them.
On that same theme of empire building, growth by acquisition has been the Achilles Heel of many management teams. The former management team at SUPERVALU (NYSE: SVU) teamed up with CVS (NYSE: CVS) in 2006 on an ill faded acquisition of Albertsons. In the $17.4 billion dollar deal, SUPERVALU added 1,124 stores to bring it up their count to 2,656 stores. For its part CVS added 700 stores to bring its total to 6,100 stores. Then SUPERVALU CEO Jeff Noddle said of the deal, "This acquisition is a strategic fit with Supervalu's approach of operating a diversified portfolio of regional banners— managed and branded— strong prevailing market shares." He further went on to say "By adding prestigious supermarket nameplates across the country, each with strong market presence in their respective regions, we will have the critical mass and footprint to leverage the combined operations to become a more profitable business." Today SUPERVALU trades for a mere fraction of the value of that deal as just a $1.2 billion dollar enterprise with just 1,100 owned retail stores as it has either sold off or franchised many stores in the years since. CVS, which was biting off a much more manageable piece in the deal now as 7,300 stores as they didn’t require the massive amount of debt like SUPERVALU in order to complete their end of the deal.
In the case of A&F or SUPERVALU their management teams might have made better capital allocation decisions if they took a step back and asked the question, what would my replacement do? Or even better, does this decision benefit our stakeholders? So to can investors benefit from asking the same questions. A really good exercise for any investor is to take a step back and ask the hypothetical question, if someone else took over my portfolio what would be the first thing they would do? Is there a holding your spouse would cut if they could? Would your kids think you are crazy for holding out to buy the next big thing a few dollars cheaper? We can look at a lot of things such as company acquisitions, store closings or closing down whole divisions in hindsight and debate their merits years later. Instead, we should take a step back and think what decision a replacement might make and consider whether or not it should just be done.
latimerburned owns calls on SUPERVALU INC. The Motley Fool owns shares of Intel and SUPERVALU INC. Motley Fool newsletter services recommend Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
