20/20 Hindsight: My $12,000 Mistake

By William Bias - June 7, 2012 | Tickers: EBAY, TR | 0 Comments

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Opportunity cost is something I try not to think about.  In my opinion, opportunity cost is limitless. Pondering that one should have done A rather than B or C or D can drive a person insane. Investopedia defines opportunity cost as "The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action." For example, if you invest in one company that returns 1% and the investment you didn't choose goes up 2000%, the opportunity cost is 1999%.

Way back in 1998 I had $650 to invest. eBay (NASDAQ: EBAY) had just gone public. I was also looking at a candy company, Tootsie Roll Industries (NYSE: TR), with conservative fundamentals. As I was looking at the initial filings from eBay, I noticed that unlike most dot.coms of the time, it actually had profitability. I knew that if dot.com companies without decent fundamentals were doing well, then one with good fundamentals would do even better. You might be thinking, “yeah, right.” but this is one case where my conservative approach to investing cost me a great deal, and if I was presented with a similar set of circumstances it would probably happen again. What happens in the past doesn't necessarily translate into results for the future.

Back to my story. As I was looking at the fundamentals of eBay and Tootsie Roll I was thinking, here is a dot.com with profitability and a well established, conservatively financed, candy company. eBay had an untested business model of bringing people together to buy and sell. At the time I was seeing the whole internet as untested and a trend that could fade into obsolescence as people moved on to the next thing. I am really conservative in my approach to investing, so I went with the established well known brand name and bought 25 shares of Tootsie Roll. I was disheartened to watch eBay shoot through the sky as my Tootsie Roll stock just sat there. A few years later I sold my Tootsie Roll stock for personal financial reasons at a slight loss. I put that issue aside and moved on with life, but it still kind of ate at me. Years later I decided to revisit the issue and pondered: Was it a mistake to sell Tootsie Roll? What would have happened to my $650 investment had I invested in eBay instead of Tootsie Roll, and kept it until present day? And, how can I learn from this experience for the future?

According to Yahoo Finance's Chart the total return for eBay from the week it went public to May 29, 2012 was 1976%. In other words, my $650 investment would have become $12,844. Tootsie Roll's return over roughly the same time period is a loss, -17.98%, not including dividends. This means my $650 would now equate to $533.13. Factor in total dividends of $127.75 (see Footnote) paid on the original 25 shares and the return would amount to a total of1.7%, which would have given me a grand total of $660.88. This all equates to an opportunity cost of 1974%. Comparing Tootsie Roll and eBay from a business perspective is like comparing apples and oranges. Looking towards the beginning of the last decade, Tootsie Roll’s profitability was impacted by the recession. Then, they started to experience high commodities inflation for the materials that go into making the candy. In annual reports  from 2006, 2007, 2008, 2010, and 2011 the CEO, Melvin Gordon and the COO, Ellen Gordon, would start off somewhere in the first few paragraphs explaining profitability pressures with a phrase similar to this, "Our margins have continued to be pressured by substantial price increases in several key ingredients used in candy manufacturing." Tootsie Roll has always had a good balance sheet with a light debt load, but high commodities inflation has hampered growth in profitability and hurt its share price in the process. Also, it looks like Tootsie Roll's largest percentage of revenue comes from domestic sources, which means it never expanded heavily into foreign markets like eBay.

Tootsie Roll Graphs:

eBay never had to deal with a materials increase in commodity prices. This dissolution of the "internet trend" or the "yard sale" model that eBay had pioneered never happened. In fact the internet yard sale model has become quite sustainable. It is cheaper and less cumbersome to place items on eBay than to rent a flea market booth and spend a weekend hoping someone will buy what you have to sell. It has lowered the barrier to entry for many people to go into business for themselves. eBay has also further capitalized on this trend by introducing PayPal, making it easier and safer to buy and sell not only on eBay but the internet as a whole.

eBay Graphs:

I have learned 3 things from this study:

1. Past results do not guarantee future results.

2. I learned my real tolerance for risk. One really has to take a leap of faith into a new business in order to experience huge gains. I didn't want to risk my money on an unproven model.

3. Opportunity cost is infinite in the large universe of publicly traded stocks. Acknowledge that it exists and strive for superior investment gains by investing in companies with good growth prospects, fundamentals and a price below intrinsic value.

Footnote:

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