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Whitney Tilson Asks “Why can’t I find any stocks to buy???; Largest Short Position Is Wingstop

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Excerpted rom Whtiney Tilson’s email to investors entitled ” Why can’t I find any stocks to buy???”


Also see his Wingstop thesis WINGI’m considering writing an article about this, but wanted to circulate my thoughts to my investing email list first to ask for feedback.


I’m trying to figure out why I can’t find any stocks to buy. While that’s not quite true – I’m currently long 10 stocks – I’m sitting on 46% cash right now.


The simple explanation for the dearth of stocks to buy is some combination of: we’re in one of the strongest bull markets in history (a month ago we passed the 8th anniversary of its start in March 2009), valuations, while high, aren’t extreme, interest rates are low, the economy is plugging along, there’s a new pro-business administration in the White House, etc., etc…


But we’re also in a very narrow market. As of today’s close, the S&P 500 is up 5.8% YTD and the Nasdaq is up 9.5% (both including reinvested dividends), but the Russell 2000 (the 3000 largest stocks in the U.S. market, excluding the largest 1000) is only up 0.53% and the S&P 600 SmallCap index is down 1.25%. Why the disconnect? Because the gains in the major indices are being driven by only a handful of popular stocks like Tesla (up 42% YTD), Apple (24%), Facebook (22%), Amazon (19%) and Netflix (16%). Even “laggards” like Google and Microsoft are still up 6% YTD.


In my two decades of investing, I’ve experienced many complacent bull markets yet have always found plenty of cheap stocks to buy, especially when markets get narrow. For example, in the Nifty Fifty/Internet bubble in 1999/early 2000, as all the money poured into the favored sectors/stocks, there were a ton of cheap “old economy” stocks like Berkshire Hathaway, which got cut in half from $80,000 to $40,000 from early 1999 to early 2000 (in fact, it bottomed the day the Nasdaq peaked on March 10, 2000 – a day I remember well because I made Berkshire 30% of my (tiny) fund that day). Many stocks of good old economy companies were trading at 5-7x earnings.


Today is not really much like 1999, but I’d still expect to see some cheap out-of-favor stocks – yet I’m finding almost none.


To see what I mean, here are examples of three of my best investments over the years – turnarounds of a great company, a good company, and a mediocre company:


  • McDonald’s from ~2000-early 2003 had, if I recall correctly, had something like 24 consecutive months of negative same store sales, Jim Cramer called it “uninvestable”, and the stock tumbled from $45 in late 1999 to a low of $12.31 in March 2003 (another day I remember well, as I’d bought the stock on the last day of 2002 ~$16 and watched it fall another 25%, at which point I made it a 10% position) – and the rest is history. Here’s what the stock chart looks like since 1/1/03 (I sold in 2008):


  • Office Depot was a very good business nearly two decades ago (before Amazon), yet the stock plunged from ~$24 in 1999 to $8 (where I started buying it) to as low as $6 in mid-2000. The company brought in a new CEO with a plan to turn the business around – and it worked, as this chart shows:
  • CKE Restaurants (which is now private) owned an excellent business, Carl’s Jr. restaurants, and then acquired what was then the worst restaurant chain in America, Hardees – and it nearly sank CKE. The stock, which peaked at $13 in early 2002 plunged to $4 (when I started buying) and later hit $3 in early 2003 (when I bought more). The company’s new Thickburgers became a hit, as I expected, and the stock went to ~$20.


In each case, the companies encountered difficulties and their stocks fell by ~75%, presenting an extraordinary buying opportunity for value investors like me who correctly foresaw that the companies would turn around.


Today I’m not finding situations like these. There are, of course, plenty of companies reporting lousy results and, consequently, have beaten down stocks – but not beaten down enough for my liking. Instead of falling, say, 75% to a price that’s cheap enough for me to buy, they are instead only falling, say, 50%, remaining (vexingly) above the price at which I want to buy.


Take Barnes & Noble, a stock I’ve been both long and short over the years. The stock has been cut in half over the past two years, as this chart shows:



Today, it trades at only 0.2x revenues and 4.0x EBITDA, but as this chart shows, revenues are declining rapidly and the company is barely profitable:



In light of the enormous headwinds Barnes & Noble is facing, which I think are likely permanent, its stock should be down 75%, not 50% in my opinion.


Among big caps, even companies facing big headwinds that haven’t had an up year since 2011 or 2012 are trading at rich valuations. Here are two examples (with apologies to Buffett):


Coke today trades at 5x revenues, 17x EBITDA and 29x trailing earnings – for a DECLINING business?! As this chart of revenues and operating income shows, Coke hasn’t had a good year since 2011:



Or consider IBM: while the valuation isn’t as demanding as KO at 10.6x EBITDA and 13.6x trailing EPS, its business has been in an even more severe decline over the past six years, as this chart shows:



Among smaller companies, even those that report big misses have expensive stocks – consider LULU, which despite blowing guidance for the year and taking a 23% hit in one day last month, still trades at 2.7x revenues, 12.0x EBITDA and 23.0x trailing earnings. Or my largest short position, Wingstop (WING ), which today trades at 10.4x revenues, 29.5x EBITDA and 52.4x earnings despite:


1) This gross margin trend (and guidance for 2017 implies another ~300 bps of gross margin decline):



And 2) This same store sales trend (note that management on the Q4 call confessed to MINUS 2.6% SSS in the first two months of 2017):



So, to repeat my original question, why aren’t all of these stocks a lot cheaper??? Who is stepping in and buying them here, keeping their prices elevated at too-high levels – prices well above where they would have crashed to in earlier years?


I think there are three possibilities:


1) Active managers. No doubt some active managers (both of mutual and hedge funds) are abandoning their valuation principles and buying beaten up companies/stocks before they become really cheap – but given the outflows of capital from all active managers, it’s mathematically impossible for them to buy net buyers – rather, they must be net sellers to meet redemptions.


2) Index funds. There’s been a huge rise in indexing, which is clearly a major factor driving/supporting the stocks of big companies, both those in favor like AAPL, FB, and AMZN, but also even those out of favor like KO and IBM. But this doesn’t explain smaller stocks like BKS, LULU, WING, etc.


3) Quant funds. I don’t understand the quant world very well, but the article below from today’s WSJ makes me think that some of these funds, which are growing (QuantWorld is up to $5 billion and Two Sigma is now $45 billion, and the actual amounts invested may be far higher with leverage), have developed value-style algorithms that mimic the core of my strategy: look for good companies encountering temporary problems and buying their stocks when they sell off. As you can see from the examples above, to make great returns on MCD, ODP and CKE didn’t require buying down 75% – one could have bought when their stocks were “only” down 50% and still made a fortune. Et tu, quant funds?


If I’m right that index and quant funds are screwing things up for value investors, what are we do to about it? Closet index? Be willing to buy beaten down stocks are higher prices? Or just be patient, look for the occasional idiosyncratic/opportunistic situations, and wait for some market turmoil to really put a lot of money to work? For now, I’m doing the latter. But it sure is frustrating!

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