Pawn Stars just happens to be a TV show I watch, and a TV show I watch religiously. I watch it because the Pawn Stars are some of the world’s best investors.
Investing Like the Pawn Stars
The Pawn Stars are pretty awesome investors. They understand that they should never buy something they don’t understand, and more importantly, never buy something that poses a significant risk to the business.
Now, whoever produces the show is really good at making really good investments look like terrible investments. Case in point: the Pawn Stars buy all kinds of major equipment, including a few hang-gliders and things that really aren’t in your typical pawn shop.
In almost every episode, Rick sweats some major purchase as if he’s actually concerned about making money on the deal. But what you’ll notice is that the Pawn Stars always look for a margin of safety. If Rick’s gonna throw down $2,000 for a hang glider, he’s going to make sure that, no matter what, he doesn’t lose the entirety of his investment.
Usually, though, he gets one of the best margins of safety one can find: he buys stuff for less than its liquidation value. If he’s paying $2,000 for a hang glider that might retail (after further investment) for $8,000, he almost always makes sure that the parts alone are worth $2,000.
There are really only two outcomes:
1) The Pawn Stars end up selling the item for its liquidation value, potentially making zero when you account for the time of employees and the time value of money.
2) The Pawn Stars end up seizing a better opportunity by further investing in the item to give it a higher valuation relative to the investment and risk. Their total margins on these kind of investments appear to be huge—they’re so large that they outsource almost all of the work required.
I invest like the Pawn Stars
I’ll give you a perfect example of a security I own that I purchased in much the same way as the Pawn Stars. The company is Wireless Telecom Group, Inc. (WTT). At the time of writing it’s worth less than $25 million and under $1 a share.
Now, these kind of securities are usually off people’s radar. For one, it’s a tiny company. I say that with a half-smile—99.9% of people who say that small cap stocks are too small would love to own a $25 million business. I’m always stunned when people reject the notion of buying a piece of a business, when they’d be happy to own the whole of it.
Secondly, it’s a penny stock, which doesn’t mean much to me, but it’s a negative qualifier for a lot of people in much the same way that a hang-glider is off the investment radar for individual investors, but not for the Pawn Stars.
This is a company that inspired my post on activist investing, which was timed perfectly to that nasty dip in the summer. I held my nose tight and bought more, while penning an article about how much I’d love to slap the CEO/CFO team silly. In truth, it’s a pretty lame business–and I’d still like to slap the executives. But that doesn’t make it a bad investment.
I bought this company because it has current assets worth roughly $25 million, and total liabilities of $2 million. My average price means I bought a piece of the business (a profitable company) for less than the value of the cash, inventory, etc. on hand. Basically, I had a very serious margin of safety. I stole the damn thing.
There are two possibilities for this stock:
1) It goes nowhere, just as it has for much of the recent past.
2) Investors realize its potential and pay for it, at which point I sell.
3) A competitor (probably Micronetics Inc. NOIZ) buys it out for their customer list/cash flow and pays a healthy premium for it. As is common with small caps, executives are paid too much. That’s a strain on the present market value, but not the buyout value. A business in the same industry could easily buy the company and give the current execs the finger, putting someone already in the firm (cheaper) in charge of both operations.
Get Companies for free!
I got the business itself for free. Seriously, I never paid a penny more than $.78 for any of the shares I hold in this company. At that price, I was buying a company with $.66 of cash, $.25 of inventories, and roughly $.12 of accounts receivables per share. That’s $1.13 in assets for a $.78 investment. AND I got the future earnings potential of all those assets to boot.
There aren’t many opportunities like this available in the equities markets. Most companies that sell for less than their net current assets aren’t worth owning. But, I enjoy nothing more than reading form 10-Ks and Qs and doing business analyses so it’s 1) fun as hell and 2) profitable as hell. And, if you enjoy that, you can find plenty of stocks like these that sell for less than their intrinsic value (in terms of net current assets, and future cash flows.)
“It is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately with people or it doesn’t take at all. It’s like an inoculation. If it doesn’t grab a person right away, I find that you can talk to him for years and show him records, and it doesn’t make any difference. They just don’t seem able to grasp the concept, simple as it is. There seems to be some perverse human condition that likes to make simple things difficult.” Warren Buffett
That’s neither here nor there, though. My point is that when you look for potential investments, always look for the inherent downside protection—I don’t care if you’re investing in hang-gliders, cars, or potato chips. Having a margin of safety is the surest way to beat the market day in and day out.
(Sidebar: This particular security is one of four I included in TheFinancialBlogger’s 2011 stock picking competition. In all, WTT, ADGF, CNU, and MDF were included. CNU was bought out by MDF for a 37% premium to Jan 1 price. MDF is up 63% this year. ADGF is up 13% and WTT is up 26%. All of these were my super margin of safety picks–tiny companies with big potential selling for way less than what they’re worth.)
Photo by: berenicegg