Geoff Gannon – Watch the Weight of High Debt And Operating Leverage

Nov 14, 2019

Ask episode

Chapters

Transcript

Episode notes

Geoff Gannon is a portfolio manager, podcaster, and investment writer. He manages accounts at Focus Compounding Capital Management, and he co-hosts the Focus Compounding Podcast with Andrew Kuhn.

He started writing and podcasting about value investing in 2005, at the ripe young age of 19. Since then, Geoff has written hundreds of articles for Seeking Alpha and Guru Focus. He wrote the Gannon On Investing newsletter in 2006 and two GuruFocus newsletters from 2010-2012. In 2013, he co-founded Singular Diligence (a monthly investment newsletter) with Quan Hoang and authored all issues from 2013-2016.

In 2017, he co-founded the Focused Compounding member website (with Andrew Kuhn). In 2018, he co-founded Focused Compounding Capital Management, where he manages client accounts. Lastly, in September of 2019, Geoff Gannon and Andrew Kuhn announced their partnership with Willow Oak Asset Management, a subsidiary of Enterprise Diversified Inc (SYTE US), to launch a hedge fund with a target launch date of January 1, 2020.

“If you have a monopoly or something like that, it’s okay to have a lot of operating leverage and a lot of debt.”

Geoff Gannon

Worst investment ever

Geoff got into investing as a teenager when he dropped out of college after one semester. He figured college wasn’t his thing. Instead, he wanted to do something related to investing as well as writing. So by the time he made his worst investment, he’d packed some good years of experience in investment and risk management.

Even the most experienced investors make blunders

Geoff’s worst investment ever was a personal investment. He’d been interested in the Weight Watchers stock for a long time but didn’t buy it as the price was always too high for his liking. He’s a value investor and likes to pay a low price for things.

The lucky star shines on the seasoned investor

As luck would have it, a couple of factors affected the price of the stock. The controlling shareholder decided that they should take on a lot of debt and buy back a lot of stock, which caused the stock price to shoot up.

However, the price got so high that nobody wanted to buy it, which then caused the price to drop more than it should. Suddenly he was looking at the cheapest stock amongst its competitors, some that he never thought were as good as Weight Watchers. Now he got pretty interested in the stock.

He goes against his better judgment

Weight Watchers was a controversial stock at that point. But he liked the price, and it had all the things about a business that he liked as well. However, Weight Watchers had more debt than companies that he’d normally buy. The $33 per share stock price got him to ignore the debt and its possible consequences.

Over the next year or so, the stock declined to the lowest price it has ever hit—$4. The price did increase after an announcement by Weight Watchers that Oprah was partnering with them. He ended up selling his shares at $17, making a 50% loss.

Lessons learned

Don’t invest in a high debt stock

Geoff’s biggest lesson was that when buying stocks with high debt, you ought to consider the type of product or service the company is trading in. When a predictable company, for instance, an airport or any monopoly, take on an excessive amount of debt, the stock remains safe.

However, a company like Weight Watchers is less predictable because they offer products that people will not hold onto for long. The average Weight Watchers member only stays with the diet for about nine months, meaning customers decline if they don’t get to sign up new ones.

If the company had not taken on an excessive amount of debt, if they'd kept it pretty reasonable and low, that would probably have changed the trajectory of the performance of that stock.

Think about fads too

Before Geoff bought into the Weight Watchers stock, there was a buzz around the Atkins diet. It became this huge phenomenon beyond anything that any diet had been before for about a year. It did a huge amount of damage to the Weight Watchers business that year.

Geoff Knew from research that the Weight Watchers stock declined a lot with the Atkins diet. He made the mistake of thinking that that was a one-time thing, but other fads such as apps and other diets came up and continued to affect the price of the stock.

Andrew’s takeaways

When looking for stocks to buy pay attention to the company’s debt

Most people never take time to research whether the company they want to buy into has any debt. Now that’s a risk management mistake because debt can creep up. Even though it doesn't cause a problem most of the time, but when it does, you can lose the shareholder value in the business that you are investing in.

Investing in the stock market for the first time? Start slowly

When investing in the stock market for the first time, it pays to start slowly. When you find an investment idea that you think is viable, go in slowly and give yourself time to monitor its performance. This saves you from experiencing buyer's remorse.

Actionable advice

Geoff’s advice is if you're going to buy the stock of a company with debt, take your time thinking about the debt itself and whether it's a good investment or not. Ask yourself if you invest in this debt will the company be safe or at risk of bankruptcy? And if it's not, then maybe you don't want to invest in the stock.

No. 1 goal for the next 12 months

Geoff’s number one goal for the next 12 months is to have a successful launch of his hedge fund because the first year is very important in terms of starting things off. So that'd be a great goal to have a good first 12 months.