When It Comes to Investing, Let History Be Your Friend

By Berna Barshay

Tuesday, June 8, 2021
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► Getting to know companies over the years can be an invaluable asset for beating the market…

If you have a long memory of a company and know its history and management inside and out, it’s a lot easier to swoop in when a great buying opportunity presents itself.

Companies that are otherwise unimpaired see their stocks stumble all the time because of relatively minor events, like lowering guidance or an executive stepping down. Other times, a business may be getting appreciably better or worse in terms of its future prospects.

In both instances, having historical context can be crucial in identifying great value.

I’ve been watching many companies for more than two decades now. One company familiar to regular readers of Empire Financial Daily is L Brands (LB). It’s the parent company of lingerie chain Victoria’s Secret and Bath & Body Works, a mall retailer of soaps, candles, and other home fragrance products.

As I explained in the May 22, 2020 Empire Financial Daily, Victoria’s Secret was once considered one of the best specialty retail businesses in the world. It had a dominant market share within lingerie in the U.S., near-universal brand recognition, and exceptional, industry-leading margins thanks to both its scale and its pricing power.

After many years at the top of its industry, Victoria’s Secret started to stumble. It saw revenue growth slow down considerably in 2016 and eventually turn negative in 2017. Operating margins began to drop.

As company performance declined and the stock fell, many investors tried to justify the fall from grace.

Some attributed the chain’s troubles to a fashion trend toward “bralettes”… a kind of wireless bra that was taking a bite out of the market for the sexy push-ups that Victoria’s Secret was famous for.

But I could tell that something bigger was going on…

Something was off in the company’s decision-making. In a move I still don’t understand, Victoria’s Secret voluntarily exited its swimwear business in 2016.

Victoria’s Secret had been one of the top destinations for swim for regular women seeking affordable, full-coverage bikini tops. Women who visited primarily for swimwear every year would also end up buying underwear, sleepwear, or other products. Swimwear was a gateway to the brand for many customers. I never heard a good defense of this decision-making from the company… and now, five years later, Victoria’s Secret is re-entering the category.

Other signs of poor judgment continued, including a lack of diversity in the models selected for advertisements. The millennial and Gen Z customers that the chain sought expected – and demanded – a more inclusive vision of beauty for race and size. Management didn’t recognize that social and cultural change was happening… or if it did, it refused to acknowledge it.

By the end of 2018, Victoria’s Secret was widely lambasted in the press for its out-of-touch marketing. Its overtly sexy imagery and narrow definition of beauty had once felt merely anachronistic, but suddenly it was regarded as offensive as the #MeToo movement took hold.

The company’s missteps at that point were widely understood. And as a result, LB shares fell nearly 75%, from a high of more than $100 in 2015 to around $25 by the end of 2018…

L Brands was a classic value trap all the way down…

People saw the historical margins and thought that problems were temporary. Investors expected a reversion to the mean – that the company would go back to performing as it had for so long.

They figured bralettes would go out of style, and push-ups would come back. The next marketing campaign or set of products would turn it all around. My male colleagues (who I assume never wore a bra in their lives) would tell me a life-changing one was just around the corner… because that’s what the company told them.

I remember at one point the declining same-store sales were attributed to dressing rooms that were in desperate need of a refresh, which Victoria’s Secret was in the process of doing.

At that time, a good male friend and analyst sent me into a store to check out one of the new, renovated dressing rooms. While he waited on a rainy street corner for me, I checked out the fitting room. Spoiler: The new wallpaper wasn’t going to fix the company’s problems.

Back when Victoria’s Secret was putting up the peak operating results, it had an exceptional handle on the era’s zeitgeist. I remembered those years well. It knew what women wanted, aspired to be, and believed in. Over time, women’s aspirations changed… but the company didn’t.

By 2019, the source of Victoria’s Secret’s woes was generally well-understood…

But at that point, most of Wall Street had left it for dead.

After recognizing that something was broken and avoiding the value trap all the way down, I started getting super excited about the stock as having a deep value in 2019.

I knew that L Brands’ other asset – Bath & Body Works – was a true gem… And as LB shares continued to sink deeper into the $20s, the value ascribed to Victoria’s Secret started to approach $0 rapidly.

Some people thought that was correct, and that the chain was beyond repair. But having covered the company for 20 years and been a customer at different points for 30 years, I felt Victoria’s Secret wasn’t a totally lost cause.

Bras are one of the toughest apparel categories to size and source properly, and Victoria’s Secret still had huge scale and experience advantages. Due to its longtime position as a top retailer, the chain also generally had excellent locations within malls. The continued strong performance of Bath & Body Works and the sheer number of stores between the two concepts gave L Brands a lot of sway with landlords.

I also believed in the power of nostalgia in branding… I had seen brands like Tapestry’s (TPR) Coach, Puma (PUM.DE), and Kering’s (KER.PA) Gucci rise from the ashes of near obscurity to periods of high growth and category dominance with a change of marketing message or design team. With brands, legacy matters.

My qualitative judgment told me that properly managed, Victoria’s Secret was salvageable. My quantitative analysis told me that at points, LB shares implied the lingerie chain was worth nothing – or worse, had negative value, despite nearly $7 billion in annual sales.

The pandemic actually handed L Brands a huge win…

Just prior to the outbreak, L Brands agreed to sell 55% of Victoria’s Secret to private equity firm Sycamore Partners in a deal that valued the company at around $1 billion. I thought it was the steal of the century.

Then the pandemic struck, and Sycamore walked away from the deal in May.

It was an awful time for retail, not to mention the rest of the world.

But nothing had permanently changed at L Brands… And in fact, for the first time, I was seeing a shift in its marketing to be more inclusive and welcoming to diverse customers.

At this point, I highlighted L Brands in Empire Financial Daily as a good buy for long-term investors tolerant of a little volatility. Having followed the company for so long, I could see subtle “green shoots” at Victoria’s Secret. And I understood what a great business Bath & Body Works is… and how little investors were paying for Victoria’s Secret when you stripped the value of its sister chain out of LB shares, which were trading for just $15 at the time.

Now, let’s fast-forward a couple of quarters…

As expected, Bath & Body Works has minted money during the pandemic selling soaps and hand sanitizers… and Victoria’s Secret is finally turning things around. Product and marketing improvements have led to “less bad” sales declines while operating margins have exploded.

L Brands plans to spin off Victoria’s Secret by August 2021 to create better transparency and unlock value at the two chains. Expectations now are for Victoria’s Secret to fetch more than $4 billion… four times what Sycamore balked at paying.

Things are looking up, and the shares have climbed nearly 340% since the first time I told readers about them…

Avoiding the value trap on the way down was hard. Staring into the abyss at the bottom was harder.

But having followed the company for more than two decades, I had the context and confidence to avoid losses… and jump in when the stock was ready to rip higher.

Later this week, I’ll break down how to find more of these triple-digit winners…

In a free event on Thursday, at 12 p.m. Eastern time, I’ll be joining my colleague Whitney Tilson for Empire Financial Research’s first-ever Wealth Accelerator event. We’ll explain how you could begin collecting a long string of triple-digit gains, starting with an investment as small as a few hundred dollars.

It’s a chance to accelerate your wealth with an opportunity that most investors overlook completely… and it has nothing to do with options, cryptocurrencies, or any other complicated investment strategies.

This event is 100% free to attend, but make sure to reserve a spot in advance – you can do so right here.

In the mailbag, more reactions to the drama at AMC Entertainment (AMC)…

Are there companies that you have followed for years? Do you agree that coming back to the same well more than once can not only save time but also enhance returns? How often do you come back to old favorites to buy their stocks? Send an e-mail to [email protected]

“Hi Berna, I have had some decent success stepping in front of some of the meme trades… I missed GameStop (GME) – the first squeeze but caught it the second time – and made 80%, and l have made about 70% on AMC collectively. During this run, I capped myself by selling a covered call with a $40 strike. I thought it wouldn’t be reached, but clearly, I was mistaken and will get called on it. I’m going to miss out on a lot of upside, but nobody ever went broke taking a profit.

“The most lucrative trade, however, is one that seems to fly completely under the radar… because of the price action in these meme stocks, the implied volatility on options is through the roof. I’ve been writing puts on GME for expiration in 2023. I wrote dozens with a $5 strike when it was trading at just over a dollar and closed them when they dipped below $0.50. The $7-strike put was as high as $1.30, and I wrote dozens there too, as well as the writing $12s and $15s. In fact, as the price of GME has nearly doubled in the last two weeks, the premium on (those) puts has actually gone up.

“To be honest, when I go through the Reddit posts and see these guys posting their massive gains. Some with small bets, some with much larger bets, and all age groups – teens down to seniors – I’m actually very happy for them. Clearly, many of them feel like the system is very much stacked against the little guy. And for a change, they are the ones running the show. I just hope when the party ends; these guys end up coming out with something to show for it. GME’s thesis for long-term growth actually has potential since they are trying to revamp their strategy and innovate. I have no idea what AMC’s long-term plan to actually make money is, other than diluting shares every time something like this happens.” – K.S.

Berna comment: Great work with those put sales, K.S. Although I would warn other readers that while implied volatility is indeed extremely elevated in AMC (and GME), knowing how to play this volatility is a specialized skill. If you are going to play these options, keep your positions small – unless you are truly an expert options trader.

“Berna, I’ve shorted five meme stocks profitably the past two months on any crazy move up. Today I’m losing on my AMC and GME shorts – but not nearly as much as I have made. The tried and true is to only invest enough to stay solvent through irrational markets, that is the whole ball of wax.” – Gene N.

Berna comment: I agree with you, Gene. Position sizing is key in these situations.

Regards,

Berna Barshay
June 8, 2021

Whitney Tilson
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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to more than $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor’s degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

Click here for the full bio.