Motley Fool Hidden Gems Investing - Turnaround Stories and Shorting Stocks

Starting point is 00:00:00 We're talking short sellers and turnarounds today on Motley Fool Hidden Gems Investing. Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime Fool contributors, Lou Whiteman and Matt Frankel. We're going to be getting into short sellers, specifically short selling research firms after the court decision that came down on Citron Research earlier yesterday. We're also going to look at investor questions related to real estate on the private side, not necessarily REITs that we normally talk about on a publicly traded entity show. But first, we're going to start with Dollar General. And I wanted to bring this one up specifically because it's been like a turnaround

Starting point is 00:00:43 story for several years. It's not the most headline-grabbing company, but during the 2010s, Dollar General was one of the best-performing stocks. It handily beat the S&P 500. And companies that we think of now in like mag seven companies like microsoft and alphabet dollar general was beating it that kind of came to a crashing halt right around 2022 as some trouble started to pile up for various reasons and the company's been trying to get its act together for a while now and today this morning it just reported earnings and the numbers said they beat expectations and raised guidance and yet the stock is down about almost three percent as we're taping this so matt was this a good result or was it just kind of beating bad expectations for what is now

Starting point is 00:01:29 kind of a downtrodden stock? Yeah, well, I mean, Dollar General, you're right. They beat expectations on earnings. On revenue, they missed expectations a little bit. It wasn't all good. Same store sales, for example, grew 2% year over year. That's less than the rate of inflation. So on a real basis, they actually lost same store sales. On the other hand, I mean, their margins look good. Gross margin rose 65 basis points, net income increased by 13%. And as you mentioned, earnings beat expectations. So it missed slightly on the top line, beat on the bottom. I'm not shocked that the stock is under pressure. The company is making good progress on its plan to renovate and improve its existing stores, which is a big cornerstone of their turnaround plan.

Starting point is 00:02:08 They did 1,400 of them in the first quarter alone. They're aiming for a little over 4,200 for the entire year. They continue to open stores when they see opportunities. Almost 200 new stores were open during the first quarter. They maintained the revenue guidance for the full year, but they raised their earnings guidance. So I'd say things are going okay. They're not going great, but they're going okay. Yeah. Maybe the market debate is in the word good, in good progress. Because yes, there's definitely making progress here, right? This is a promising start to what figures to be a long-term turnaround. They were beaten down, rightfully so, I may add. And the market right now is not in the, I don't think they want to celebrate just one quarter of a turnaround.

Starting point is 00:02:51 They have an ambitious plan. There's nothing in this quarter to suggest that there's anything wrong with the plan, but this is competition is intense here. In retail, there is no guaranteed winner. You are not entitled to continue to exist. So there is real downside risk. Turnaround, still early days. I think, you know, you give credit where credit is due, But I think the market's right to be cautious here and not to just be cheering just because of one quarter's results. I feel like the three of us have been in the same experience here for a while, where I've been to a few value investing conferences over the past three years.

Starting point is 00:03:26 And I think I've heard so many dollar general pitches at these value investing conferences. I feel like I could set my watch to it and almost do the whole pitch by memory now. It all had struck the exact same chords. It was like former CEO Todd Vezos is now back in charge again after, you know, that 2020-2010 kind of run up and like he's the one in charge again. The stuff that's a problem, it is fixable, right? And if you focus on the current store fixing to like you were talking about, Matt, in the most recent numbers, instead of really like trying to blow out your store count, which was part of the growth narrative and why it was so successful. You know, all these things happen and, you know, boom, we're back at a two times price to sales ratio, eight times book value. And some of these things are coming true.

Starting point is 00:04:13 Sales continue to grow. Margins are improving. But at the same time, that valuation standpoint, it hasn't come anywhere close to it. We're still less than one times sales. I think book value is something like two, two and a half times book. The valuation is way different. And this is the challenge, in my opinion, of investing in turnarounds. I wanted to use Dollar General as a good example here, but we could have, I don't know, done

Starting point is 00:04:36 advanced auto parts or the 15 other long-term turnarounds that sometimes have not quite gotten off the ground. It's not just a bet on the fundamentals of the business returning. It's also the narrative that drives that valuation of what people think about it. And I know I certainly have touched the hot stove a couple of times. I don't even know if I can mention some of them because they're so small these days that I think we could move the stock. So I don't even want to mention them because they're in such bad shape. But with that in mind, one, if you want to share any like turnaround bets that you made

Starting point is 00:05:09 that didn't go awry or did, and what advice would you give to investors when it comes to actually investing in these turnaround ideas or fallen angels like Donald General? Yeah. So, I mean, of course, every turnaround story is different, but there are some common themes. For me, leadership is the most important variable. I typically want a CEO that's done it before, not that's run the company before, but has executed a turnaround before. Unity Software, yes, for an example, is one that I can think of off the top of my head. Their current CEO, Matt Bromberg, formerly led the turnaround at Zynga, the gaming platform. So he's done it before. The balance sheet needs more than enough money to execute on the turnaround. You don't want

Starting point is 00:05:48 to be raising capital while the company's down. And I'll almost never invest in a turnaround from to start. I want at least some evidence, you know, a few quarters of numbers moving in the right direction that show that it's working. I want to see things like same store sales growth and after inflation, like in Dollar General's case, margin trends, customer accounts growing, things like that. So that's what I look for. Yeah. So first off, I think it's so important to look at the competition just as a sign. And that's definitely true here is that, look, a company that has sort have fallen from grace or have lost the customer's eye if you're a consumer-facing company. You can execute very well, and it can be hard to get back on the radar, get back in good graces with the

Starting point is 00:06:30 customer. So I think that is a huge wild card that you have to look out for here. But generally speaking, Tyler, I think you hit on it. Narrative is so important. We are surrounded by data. The market knows everything that's going on at any given time these days, right? The hard part is knowing when the market will care about the data. A lot of sharp moves we see, and this isn't a dollar trade thing, this is anywhere, but a lot of sharp moves, it's not because there's some new surprise. It's just, we suddenly started caring about something we already knew about. Look at the SaaS apocalypse. We've known what AI wanted to do forever, but suddenly this was cutting 50% off the price of the stocks because suddenly we actually cared about it. It was in

Starting point is 00:07:11 our consciousness. In a turnaround story, the only antidote to narrative is patience. If the turnaround is working, if the data looks good, the market will catch on eventually. But that eventually can take a long time. It's really hard to know when, so patience can be needed. I find it kind of funny because you said Dollar Tree instead of Dollar General, but I actually feel like this whole segment could have been done with Dollar Tree instead of Dollar General. We might have come to the same conclusions. But before I go, anybody want to touch the hot stove? Like a turnaround that worked for you in your portfolio? One that flamed out, didn't quite work out? I'll do one of each. And I bought them at the

Starting point is 00:07:50 same time, which is again to show you that they don't all work out. I bought Garrett Motion and Simply Good Foods at the same time. One of them I think is a 3X now, and one of them is down 60%. I like both equally going in. Tyler, you were betting on Transocean's turnaround with me, so I'll just leave it at that. Coming up after the break, we're going to get into the muddy waters of short selling. Let's talk about short selling and short seller research firms in general. This isn't a topic we explore much here because we, and I'm using like the royal we of the Motley Fool, not necessarily the three of us. We don't normally short stocks.

Starting point is 00:08:32 I mean, yes, me, I sometimes use like options, like put options for income or buying a stock at a set price instead of doing like, uh, like price limits. But I think I can speak for the three of us when we say, I don't think any of us go out and say the company's no good. I'm short the stock or short stocks in our portfolio like that. Lou, do either of you guys do that? I mean, I don't want to say that I've never shorted a stock. I'm sure back in my early days before I knew how to invest, I did.

Starting point is 00:08:58 But I can't really remember the last time on occasion I'll set up, you know, option spreads or something like that that could profit if a stock I consider frothy were to go down. But even that's rare. Yeah, I stopped a long time ago. It's just too much work. The work is kind of key here. And we're talking about this one specifically because yesterday, Andrew Left of the short selling research firm Citron Research was found guilty of securities fraud. It was actually 13 of 17 counts. And I think one of them carries a maximum prison sentence of 25 years. I don't know if he's going to get 25 years, but there's some real penalties going on here. And basically, the thesis on the court case was he was using his followership on social media

Starting point is 00:09:41 and elsewhere to disseminate his research and manipulate stock prices to profit from it. Now, I wanted to bring this to the table because I have some real conflicting thoughts about this as an investor and also what we do in financial media. For all the flack that most investors give to short sellers for a myriad of reasons, some good, maybe some not. I think there's some real value to short sellers and short seller reports like the ones that Citron Research have done in the past. Do either of you agree with me here or am I kind of standing on an island? Absolutely. No, I'm 100% pro short sellers. I will say they vary in quality just like longs. That's not exclusive to the short. I don't know, and we'll get into it. I don't

Starting point is 00:10:22 know if I can be pro Andrew Left here, but definitely short sellers need to exist. Yeah, I would agree with that. There's a solid case to be made that short sellers are a vital part of the stock market. I mean, there's a lot of academic research out there that shows that short sellers improve price discovery, reduce the average duration of mispricing, i.e. bubbles, and cause less impactful crashes than otherwise would happen. I mean, short sellers have legitimately been the first to identify fraud many times. Think of Nikola, for example. Yeah. And to that point, too, like to Lou, like you were saying, you know, not necessarily the biggest fans of Andrew Leff, but Citron Research were some of the first ones to point out with all the accounting shenanigans that were going on at Valiant Pharmaceuticals. I think it was back in 2015. I think within days of that Citron research report, Valiant was making drastic changes to its business, you know, talking about changing, dissociating itself from something like the pharmacies that it was working with because there was accusations that they were using those pharmacies for overcharging. It was a pretty clear-cut fraud case that Citron brought to everyone's attention here. It was good and important work. And to your point, Matt, Nikola was a great one.

Starting point is 00:11:37 And while this technically wasn't a short report, John Carreyrou's work on Theranos was in that same spirit. I mean, I think had Theranos gone public without some of that work, I'm sure they would have made it even worse. Like we, the market, we sometimes need people on the lookout for the bad stuff, for the valiance, for the Nicholas and stuff like that, or otherwise they can perpetuate and get even worse. Now, with all of that said, and this is where it starts to get conflicting, there is something that's definitely icky about like the business model for many short sellers. And the verdict during this Citron Research court decision is where some of that icky

Starting point is 00:12:16 business practices started to come to light. And I think that's why we're kind of like, ah, don't really know if I want to stand up for Andrew Left here, right? Yeah. I mean, the big takeaway, it's not that publishing short research is inherently bad. It's not. But misleading investors is. And it's not just Citron that does it.

Starting point is 00:12:35 Muddy Waters, which you mentioned earlier in the episode, at least they say this, but they include a line in every short report that says, upon the publication of each report, we intend to begin covering a substantial majority of our short positions. And they go on to say, you agree and understand that by the time you read a report on this website, we may be covering or have already covered, i.e. bought back our short position. So this is where I have a problem. They're aiming to profit at publication and don't plan to stick around to see if their short thesis was actually right.

Starting point is 00:13:04 Always read short reports on stocks you own. Don't get me wrong. It's always worth listening to the bear case to every stock you own. Even reports where the seller just aims to make a quick buck like those, they often contain real concerns that are worth investigating. Now, Citron's general process, and this came out in the trial, was to identify a target, quickly establish a short position in it, coordinate some timing, and publish an attention-grabbing claim, either a tweet or an article, watch retail investors panic and react, sending the stock lower, and then cover into the short without

Starting point is 00:13:37 disclosing it in most cases. So one real big objection to what Matt said, I don't think that there is anyone who honestly believes that every person that goes on CNBC, Bloomberg or something and says, I think such and such is great, is committing to a timetable. If anything, Matt, like you say, at least the shorts admit this. There is nothing stopping anyone from saying on a tweet, on television or anything, I think stock A is going to the moon, see it go up 5% and sell it right away. All right. There are, I should say that for some of us, like some companies choose to put restrictions on what people can say and then act on. Motley Fool does that.

Starting point is 00:14:15 I'm all for it because I don't I agree that's not ethical. But to say that this is just some short thing, that they say something about a company and then sell off, that happens all of the time. And it feels like kind of crocodile tears to get too caught up on it just because shorts do it. What I have a problem with, and again, I don't want I want to be careful because I mean, I guess the jury has ruled, but this is still allegedly, allegedly from from the prosecution. is the idea that left was basically marketing his reputation to sympathetic hedge funds

Starting point is 00:14:45 and coordinating takedowns. That's where you sort of cross the line. There's, there's email quotes about, you know, all I have to do is go on, say something, and it'll be like taking candy from a baby when you're actually, I do think that there should be some standard of conviction to your words that you should actually be going in with a thesis. But look, if my thesis is, is this company is overvalued and I think it's going to go down from here, I say that loudly enough and it goes down. Whether it takes 20 minutes or two years, why shouldn't I cover there? The act that they do that just because they're on the downside. Betting on things going down seems just as fair to me as betting things go up. I just don't think you should be conspiring with other people to

Starting point is 00:15:31 manipulate stock prices, which is what was sort of implied with left here. You know, I'm going to do a shameless plug here for the Motley Fool because, hey, you know what? It's our podcast. I get to do that sometimes. Like, you know, we get some stocks right. We get some stocks wrong. But one of the things that you were mentioning, we do have a pretty robust like disclosure and like no trade policy. You know, if we know that a stock is going to be recommended like weeks in advance, we're not allowed to trade it. If we talk about or write about any of the stocks that you hear us talking about on this podcast, we can't trade them for like multiple days. And that's part of like the process and i think at least for me and i'm sure that you two uh agree on this to a certain

Starting point is 00:16:11 degree like it's one of the reasons i've enjoyed working for the motley fool for a long time is because yeah we get some things right we get some things wrong we can't say that we're perfect but the i think there's a level of transparency and disclosure with it when it comes to things like this that separates us to a certain degree from the citron research you know publishing something and then immediately trading on it afterwards. So, you know, if you're listening. It should be said, Todd. Go ahead.

Starting point is 00:16:38 That's more the exception than it is the rule, which is kind of why all of the hand-waving about shorts, this happens, unfortunately, a lot on both sides on Wall Street. And so if we really care about it, we should really start looking at every tweet, pumping a stock as well. Yeah. Well, you know, there's only so many Wall Street ethics episodes we can do here on a podcast.

Starting point is 00:17:02 But every once in a while, we're going to, you know, do our standing on our soapboxes. And this is probably one of them. Coming up after the break, we'll do listener questions. Hey, everyone. Quick reminder, if you want to get your questions in, we love answering them. Just send them over to podcasts at fool.com. That's podcasts at fool.com. The three quests we always ask is, number one, keep it foolish. Two, keep it short enough I can

Starting point is 00:17:29 read on air. And three, we can't give personalized advice. So always ask generic questions. So what would an investor do? Or what do you think about a stock? We can't necessarily tell you what you should do with your portfolio. We don't want to get in trouble with the SEC, like Andrew Left did. So with that in mind, here is the question from Matt. Hi, Motley Fool team. I have questions about whether syndicated crowdfunded private equity and real estate should have a place in my portfolio. Basically, the rest of it goes is, could you share your thoughts on how to safely invest in and evaluate these funds? What specific red flags or metrics should I look out for as I compare for them? Thanks for all the great content. So, Lou, I want to start with you.

Starting point is 00:18:14 private equity, real estate. This was a really popular thing, I think, 2019, 2020, where a lot of the regulations changed, where instead of having to be what was called an accredited investor, where you had to have enough either money or income to invest a certain level, they brought down those thresholds and made what they said was democratizing private equity. It's had some mixed results. And I think that's kind of what we're getting at here. So when you're looking at this particular part of the market, what are you looking for? So I get the appeal and you don't have to go far to find the appeal because they market the heck out of it. You know, diversification, there's some tax benefits maybe depending on what you're doing here, but these are not going to be

Starting point is 00:18:57 part of my portfolio. And I'll tell you real simple why. One thing, you're signing over a lot of control to whoever's managing this. Do they have a good track record? Have they navigated downturns? If it's real estate, are the underwriting assumptions realistic? There's just a lot that you are putting in someone's hands, so you better know them. But the big thing is this all matters because you're typically locked in and your capital is locked there for years on end. So you are in, you are part of this, heck or high water, however it goes. If you do want to do this, spend a lot of time on due diligence. The reason this is for accredited or socially sophisticated investors is that there aren't a lot of safety nets here. There's a lot of homework that is asked of you.

Starting point is 00:19:39 Do that homework. Spend the time breaking down the manager. Look at the plan. Look closely at the fees, because a lot of these are designed to get the manager rich, not you. Shop around. Just do your homework. Yeah, Matt, I'll let you do the final words here. But in a previous life for me at Motley Fool, I did some work on some scoring and rating of crowdfunded real estate funds. And in my assessment, the better ones were at best, you get a percentage point or slightly more on a net basis after fees than publicly traded REITs. And you had to lock up your capital in these illiquid securities. And at worst, they were launderers of fees that basically they could pitch massive yields and huge growth to the investors, but they just bought and sold a bunch of stuff within the portfolio to rack up transaction costs and management fees. And to your point, Lou, just kind of enriching the management, that was kind of the worst examples of it. In some ways, even just buying questionable real estate just for the sake of buying stuff, again, for the fees. I greatly appreciated the concept of bringing a lot of these funds, both on the accredited and unaccredited version. It was trying to make assets that were typically reserved for higher net worth of individuals more accessible to all of us. And I can understand the appeal, and I do

Starting point is 00:20:57 sympathize with that. But the regulations on this part has just been like the Wild West. And really, you're throwing individual investors to the wolves here. The reason that this has been reserved for the rich is because they could hire an army of analysts and lawyers to look over this stuff. And, you know, us weekend hobbyists don't really have the assets to make, to really do that. Yeah. I mean, I'd stay away. And this comes from someone who invested in several of these private crowdfunded real estate deals over the past, you know, five or six years. The numbers are not in your favor over, and this was an analysis over 50% of deals listed on the crowd street platform, for example, failed to meet their targets. More than 10% went to zero.

Starting point is 00:21:36 Several platforms have failed completely in the past five years, and total documented investor losses across the sector were more than $400 million across just the major platforms since 2020. Now, I'm not saying real estate crowdfunding is a scam. It's not. But the marketing really oversells the expected returns in almost all cases. Apologies to Matt looking for advice on this, but I think the best advice we can give for a lot of these things is maybe it's best to stay away and stick to the publicly traded stuff.

Starting point is 00:22:07 Like I said, maybe it's one or two percentage points lower for publicly traded REITs, but you get a lot of the advantages of liquidity and transparency. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provide for informational purposes only. To see our full advertising and disclosure, please check out our show notes. Thanks to our producer, Dan Boyd, and the rest of the Monocle team. For Lou, Matt, and myself, thanks for

Starting point is 00:22:41 listening, and we'll chat again soon.

Motley Fool Hidden Gems Investing - Turnaround Stories and Shorting Stocks

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