Sexto pecado capital: Sobreexposición. Bill Ackman
Have you ever made a fool of yourself? We've probably had it happen many times, but there are some in particular where we've gotten the short end of the stick. This is because we were probably alone, or no one saw us, and that certainly reassured us.
On the other hand, high-profile individuals run the risk of being easily exposed. A public official, a businessman, a journalist, or an actor can make a mistake on camera and become a meme in minutes. Of course, this offers certain advantages, like tweets from Elon Musk or Donald Trump, which can make stocks or cryptocurrencies rise or fall in a matter of seconds. But sometimes, one becomes a slave to one's words.
Bill Ackman is a Harvard-educated investor who, at the age of 26, began working in hedge funds with his partner and college classmate David Berkowitz. Their approach was classic value investing: analyzing companies whose stock market value was less than their true value and buying them. In a short time, the $3 million they managed grew to $568 million by 2000.
As Michael Batnick's Big Mistakes explains, he began to feel confident and take positions in companies that turned out to be less than wise decisions. The concentration of capital in illiquid positions made it difficult to handle cash withdrawals, and by 2002, he ended up closing his hedge fund, Gotham Partners.
By 2004, Bill Ackman returned to the fray, creating a new fund called Pershing Square Capital. His approach was going to be somewhat different, as up until then he had been more of a passive investor. By this, we mean someone who buys stocks, hoping that time and the market will align themselves. An activist investor, on the other hand, is someone who is deeply involved in the company. Sometimes, as in Ackman's case, they take large positions in companies to try to force changes.
Sometimes this is done in a friendly, peaceful manner, based on suggestions made in meetings with management. Other times, the issue is more aggressive, with people voting against the decision and perhaps seeking to rally other investors to support changes. Or, they may seek the necessary number of shares to appoint a director to the company and force those changes from within.
An example of this was what Bill Ackman did with Wendy's. He bought a 10% share of the company and pushed through the sale of Tim Hortons, a coffee chain. In just under a year, by 2006, Wendy's had appreciated by 55%. He tried to do something similar with McDonald's, spinning off low-margin businesses, but he met with opposition.
However, he himself admits he's one of those people who won't take "No" for an answer. Everything was preparing him for his great battle, which was about to begin years later. In all this, while in the United States investors must report when they buy more than one 5% of a company, in the case of short selling, it's not necessary. But Ackman was going to change the rules of the game by making a short sale that would prove to be historic.
By 2012, Herbalife had become their target. This world-renowned company sells weight-loss products and dietary supplements. It has been in existence for about 40 years and has expanded worldwide.
On December 20, 2012, Bill Ackman gave a presentation in front of 500 people, in which he accused Herbalife of being a pyramid scheme. Ackman commented that the company was worth more than many consumer goods companies known to Americans at the time, and that, unlike these companies, who in the audience had ever bought a Herbalife product?
The core of his argument was the fact that he doesn't sell directly to customers, but rather to distributors. These distributors, in turn, don't make any money either, according to one distributor interviewed, but rather make money by recruiting more and more salespeople. These are generally low-income individuals who enter the company with the hope of joining the millionaire team and earning $100,000 a year. According to Ackman, the real chance of reaching that figure is almost zero.
Thirteen days after the presentation, Herbalife's stock had fallen by 35%. But things got complicated because with that reduced price, two competitors, Dan Loeb and Carl Icahn, took significant positions in the company. It was a difficult situation for Ackman, because with two major funds pushing the stock price up, maintaining that short position became increasingly costly.
Despite this, as the months and years passed, he continued to maintain his short position, claiming that Herbalife was a Ponzi scheme. He was undoubtedly in a rather difficult position. If he backed down, after having broadcast his opinion about the company to the four winds, what would happen to his reputation? Who would invest with him again?
In 2016, the Federal Trade Commission convicted the company of four counts of unfair, false, and deceptive sales techniques, for which the company agreed to pay a $200 million fine and restructure its business. The following year, the documentary "Betting On Zero" was released, chronicling Ackman's fight against Herbalife.
By 2017, when the company's stock began to rise, Bill Ackman switched his position from short to put options. By 2018, Ackman closed out this position, realizing that sometimes losses need to be closed.
This lesson is very important for investors: sometimes, no matter how convinced we are that we're right, we'll always depend on others to convince us. It doesn't matter if he, you, or I think Herbalife is a scam. As long as there's a large group of people (consumers, distributors, and, of course, investors) who disagree, a bet like this could backfire. And if we're deeply exposed, it would be very difficult to change our minds, since our reputation is at stake.
Seventh deadly sin: overconfidence. Warren Buffett
We've probably seen it in a movie: before takeoff, the pilot and copilot follow an extensive checklist to ensure everything is ready for the flight. Of course, you might wonder if it's really necessary to follow it to the letter. The reality is that this was designed to avoid something that affects all of us: overconfidence. By having to follow this checklist, they make sure nothing is overlooked. A tiny mistake, or "assuming" something was working properly, or simply underestimating something because it's something never used, could mean a fatal accident.
In the world of the stock market, it's rare for a mistake to be fatal; at most, it can cause serious losses. But that doesn't mean we should avoid overconfidence. This "sin" is probably the most deceptive... because if we avoid the others and are excellent investors, we're more likely to fall into it. Even the most successful investor in history, whom we've been talking about quite a bit, Warren Buffett, has fallen into it.
The Oracle of Omaha, as Warren Buffett is known, has always been open about his mistakes. He openly acknowledges them in his letters to his shareholders, and it's an excellent way to learn from his philosophy. One of these mistakes occurred in the early 1990s.
In July 1991, Warren Buffett purchased HH Brown, an American shoe manufacturing company. In his 1994 letter to shareholders, he wrote about this purchase and what would become his biggest mistake:
“What we did last year was built on our 1991 purchase of H.H. Brown, a magnificent company that manufactured work shoes, boots, and other footwear. Brown was a real winner: although we had high expectations going in, these were significantly exceeded thanks to Frank Rooney… Because of our confidence in Frank's team, we acquired Lowell Shoe in late 1992. Lowell is a well-established manufacturer of women's and nursing shoes, but its business needs some fine-tuning.
Once again, the results exceeded our expectations. That's why we took advantage of the opportunity last year to acquire Dexter Shoe of Dexter, Maine, which manufactures affordable shoes for men and women. Dexter, I can assure you, needs no adjustments: it's one of the best-managed companies Charlie (Munger) and I have ever seen."
He was so pleased with the acquisitions that he even mentioned that when he drove to work he would sing “There’s No Business Like Shoe Business” (it’s a play on words from the song and movie There’s No Business Like Show Business, referring to the show business).
In short, the purchase of HH Brown was a success for Warren Buffett. This led him to buy another company, Lowell Shoe. But in turn, the confidence gained from these two acquisitions led him to the bad decision of buying Dexter's Shoe. He also demonstrated overconfidence in the management of both companies… while they were excellent, the problem lay elsewhere. Something Warren Buffett knew, as Alice Schroeder notes in her biographical book, The Snowball: “Here he had stepped outside his circle of competence, making a bet that the market for imported shoes would eventually shrink.”
For five years, beginning in 1994, profits declined by 571%. In his 1999 annual report, he acknowledged that since they primarily manufacture shoes in the United States, it had become very difficult to compete with imports. That same year, 931% of the pairs of shoes sold came from abroad, primarily from countries with very cheap labor. The following year, he admitted that the purchase was a clear mistake. But the worst part was that the purchase was made with Berkshire stock… he gave away 1.61% of a wonderful business for one that had no value.
In his letters to shareholders in 2007, 2014, and 2016, he continued to recall that mistake, even saying it should be "in a Guinness record." As his example shows, even the greatest investors in history made mistakes. This, to a certain extent, should reassure us. Even if we sometimes commit one of the "sins" of investors, we can still be successful investors. The stock market always punishes all investors, but it also gives us revenge.
This article is part of Chapter 4 of the book "The Pocket Investor Three: Investing for Life." You can purchase it in our store.
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