Today’s interview is about the lessons to be learned from setbacks that good companies experience, as has happened recently with Chipotle. Like buzzards on a branch, investors keep watch for the time to move or not to move. When a stock takes a tumble because of a misstep of an otherwise solid company, how do you assess the situation? What do you look for when following company stocks? Is this a fixable event and an opportunity to buy at an appropriate time or is it end of the road? With Chipotle, time will tell, and, often, just as with disgraced celebrities, forgiveness ensues and a comeback appears on the horizon.
Steve mentions the extreme drop in oil stocks which is causing a lot of investor anxiety. How long will it take for the potential benefits of low oil prices to filter through the economy and create a positive situation? Michael counters that therein lies one of the problems with contrarian investing. One must look for strong brand equity and good management, a theory that has played out by academic studies. When a founder runs the company, more often than not, he’s not necessarily in it for the money but has a passion and commitment toward his product. Again, Chipotle is a good example of this, as are Amazon and Google. Warren Buffet is a vocal proponent of this type of investing: You look for solid companies that have some kind of built-in protection against competition, who have a moat around them, combined with good branding and strong management. Coca-Cola is a case in point—tried and true and trusted.
Michael turns the topic toward credit card companies and cites American Express as one that has had to change its philosophy of exclusivity and to become more like its competitors in order to compete. However, Amex has an edge since it has its own payment system which affords them more customer information that can lead to better marketing.
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Steve Pomeranz: Michael Brush publishes the stock newsletter “Brush Up On Stocks” and writes for the websites MarketWatch.com and uponstocks.com is where you can find him. I’m speaking with him today to see what investment lessons we can learn when we see good companies experience setbacks.
Whether it’s in the form of food scares experienced recently like by Chipotle or way back when Jack in the Box in 1993 or even Taco Bell in 1996. These events happen and an astute investor can do well to truly understand and know what to do. Michael Brush, welcome to the show.
Michael Brush: Hello.
Steve Pomeranz: We have seen this before, as I just mentioned, well-regarded companies make mistakes. It’s bound to happen, everybody makes mistakes, and yet the stocks suffer big draw downs. You have to wonder if these are opportunities, and, if so, how do I take advantage of them? Of course, knowing surely that there’s risk and one has to be cautious. Michael, how does one separate fact from fear?
Michael Brush: This is probably the most important aspect of investing because people come to me all the time and they say, “Hey, you know these shoes are really popular” or “Here’s what I think about the economy,” and that’s step 1. Step 2, which is really the key step that a lot of beginning investors kind of don’t know about or leave out is has everybody else figured that out? If you know that and everybody else has and it’s priced into the stock, well, it really doesn’t help you that much. In fact, you could buy at the wrong time because you’re buying when everybody else in buying. This is sort of the inverse of that. We’re looking at kind of trying investing here and saying, “Okay, something happened,” and basically you want to ask is this a one-off event, is this a fixable event? If everybody’s frightened, and you think they’re wrong because the problem’s fixable, then you have an interesting investing situation. That’s the point here.
Steve Pomeranz: I guess the question is how do you know the difference?
Michael Brush: Right.
Steve Pomeranz: When following company stocks, you could have a company that goes down in price, but maybe they go out of business, and you can still pay too much. Or you have a company … here’s a good example, Toyota got into some serious problems with their manufacturing some years ago. So did a company by the name of Suzuki Motors that had the Samurai, this little cute Samurai SUV and, well, it’s like really a jeep. In full disclosure, I have to say I made the bright decision before the problems to buy it, so I got stuck with it like that. It’s a good example of one company disappeared and another company rebounded again. How do you tell the difference?
Michael Brush: One of the keys here with these consumer-facing companies is brand power. That Suzuki- Toyota contrast is a great one to consider. Toyota, we all know has been around for years, and they’ve had some problems; but because they had really decades worth of a reputation of selling a quality car, people were more able to say, “Okay this is a one-off issue, they’ll fix it, it will probably go away.”
Whereas with Suzuki it was kind of a new brand, it was kind of unknown. It’s the whole fear of the unknown thing, right? People were just less going to embrace that company because they didn’t know and trust the brand that well. That’s kind of the key here, you’ve got to sort of like how much brand equity is there.
Steve Pomeranz: Yeah, if you make a mistake, it’s the old joke that something’s a good buy—goodbye house, goodbye car, you know …
Michael Brush: Right, right.
Steve Pomeranz: …goodbye retirement. You have to be particularly careful. Let’s say a company that has a good brand, a good reputation, has a temporary setback, or you hope it’s a temporary setback. What can you expect the stock to do, the earnings to do? How long do you think an investor should expect the situation to right itself in order for it to become a successful investment?
Michael Brush: Okay, one of the keys here is … One of the great things about our country our culture is that we have a pretty deep capacity to forgive. We see this time and again when celebrities or even politicians sometimes run into problems people are willing to … The comeback story is a big one in America, so that’s a key element here. People also just forget. People just plain forget after a while, we’re all busy, kind of time goes by, and we forget. That’s the case here with Chipotle. The key is timing, what you can do is look back at history and say, “Okay, these situations have happened. What do we know in terms of how long it takes to wear off?”
If you look at those examples, say you cited Jack in the Box, it takes about a year for these food companies to fully recover from food scares. That’s probably what we’ll have here with Chipotle, assuming they don’t have more disasters. The other key here, remember, is the market tends to be a predictive mechanism, not always, but a lot of times it predicts, it prices things in about 6 months in advance. You have to keep that in mind, too; time is a factor.
Steve Pomeranz: I think there’s also a time variation between the event itself, which is reflected in the stock price immediately, and you’ll see that if you’re following company stocks closely. Things are marked to market based on the known facts.
Michael Brush: Right.
Steve Pomeranz: The actual event kind of filtering through the marketplace or the economy, I’m thinking about oil here as an example. Oil stocks get absolutely murdered, and people get very, very worried about what’s going to happen because the price of the oil is low. Then everybody’s going “Where are the benefits to the economy of low oil prices?” That takes a lot longer to work through the economy. You’ve got this dislocation between what’s happening right now and the fear that’s created by these big events, and yet the benefits, in the case of oil, take a lot longer to work out. It’s not an exact analogy here, but it seems kind of close.
Michael Brush: Yeah, you know that’s one of the problems with contrarian investing, and it’s a problem that I have personally. It’s very easy to be too early, and I’m often too early in names. I tend to just move right in, and it does take a long time for things to play out. I mean we saw that with the financial crisis. The early warnings were there when the Bergstrom’s hedge funds blew up and then some other problems, but that whole thing, it plays out in slow motion. Things play out slowly, and that’s a key … That’s exactly right, that’s a key part of …
Steve Pomeranz: You look for strong brand equity. I think we stated that with the Toyota-Suzuki example. What other factor do we look at when we’re looking at a particular company? I guess you’re going to want to take a close look at management to see how talented they are or passionate?
Michael Brush: Yeah exactly, management is always key, and one of the things that I always look for in companies, whether it’s Amazon or Google or even Netflix really, all names that I’ve liked early on, is when you have a founder who’s running the company that’s a really good situation. That’s proven out by academic studies. It’s really interesting to watch the CEO of Facebook who really has just gone through so many changes, and how that company’s grown, and yet he’s still there. That tells you something about the founder mentality. People are not necessarily in it for the money; they’re in it because they love to win, they love to change things, they get excited about developing new products and ideas.
That’s the kind of passion you want to see at the top when a problem like Chipotle’s comes along. That’s what we have here. We have the founder in there as manager, and I think that’s a real key to situation or any investment situation.
Steve Pomeranz: We’re not recommending any of these stocks to my listeners at all. We’re just talking about them as kind of textbook examples. Chipotle happens to be one that’s going through some tough times now. Remember to do your own research. At least, we can learn from investors like Michael Brush who are concentrating on this area and have experience in them. We were talking about the right management; and one thing that Warren Buffett looks for, he says everybody who runs the companies that he buys, they have plenty of money. They’re not in it just for the money, they’re okay. They could all stop what they’re doing and be just fine. Buffett also likes to talk about companies that have a moat around them or some kind of a protection built in in some way to fight off competition, because competition is fierce. One of those companies right now, again just using it as an example, and also that Warren Buffett has a big stake in, this is American Express.
American Express has had some missteps lately, and yet it has an iconic brand. What do you know about that?
Michael Brush: That’s right, you know Buffett loves to protect and moat and he loves to brand power. Brand power is amazing for a company. He’s a big owner of Coca-Cola, too, and that’s such a classic example of bottom line brand power. Basically, what is Coke? Here’s a company that basically sells sugar water. Now how simple is that, right? Honestly, is their product really that much better than their competitor’s? I don’t really know, but maybe in some cases. What they’re really good at is marketing. You look at all of the classic ads that are case studies in marketing, and a lot of them come from Coke. That brand power is so key because it gives you … The way one marketing professor explained it to me was, it gives you a short-cut into the brain of the consumer.
People are trained over time through evolution to learn to go to things you trust and know as a form of protection, as a form of getting safety in life and the world. That’s what brands are really, that’s what brands are.
Steve Pomeranz: You’ve got this thing that becomes known in your mind versus the rest of the world, which is kind of unknown.
Michael Brush: Right.
Steve Pomeranz: It’s just a lot easier to go with the known and trust that brand, especially if there’s no indication if they’ve ever misused your trust.
Michael Brush: Exactly. That leads to the moat, and the moat is good because it fends off competitors. It gives you pricing power. Pricing power is another key thing that Buffett always looks for. When you have a strong brand, you can charge more. That’s what American Express has done all of these years. Now, recently that’s changed for them, so they have a bit of a problem that they have to deal with. They cultivated that brand as an exclusive brand, one you can trust. Their customer service is good, and people like that. People pay up for that, and, in fact, American Express gets more out of each transaction, and they charge a lot for many of their cards.
Steve Pomeranz: They’ve come under a lot of pressure though because some big retailers have dropped them. A lot of their credit card competitors are offering money back, and lots of other rewards that American Express doesn’t necessarily offer.
Michael Brush: Right.
Steve Pomeranz: It’s a formidable brand, and it’s got all of these … this hundred years of its iconic brand building. It’s a new world for them. How does one approach a company like American Express? Do you say, “Well, they’re going to get eaten up by the competition,” or do you kind of say, “They fixed themselves in the past, let me see if I can invest in a good price here?”
Michael Brush: That’s exactly the situation with Amex now, and, in a way, it’s going to be interesting to watch because, in a way, what they’re doing is they’re becoming more like the competition. You mentioned that they lost their exclusive partnership with Costco, that flew to competitors. You have all these other credit card companies who are saying, “Hey, we’ll give you a better deal. Why are you working with Amex?” People are listening to that. Amex, as a response, is rolling out a Blue cashback…
They’re doing more cash back, more rewards. They’re becoming a lot more like their competitors. The question will be, does this dilute the brand? It will be interesting to watch. My guess is probably not. I think they will manage that from a marketing perspective and be able to beat competitors on their own turf and yet keep it’s exclusivity.
They also have a lot of data on customers. That’s going to be so key as we buy more and more online, is knowing about customers, to be able to push deals to them. This is so key. We see this with Amazon and other companies. They haven’t really worked that angle yet, but I think they will. I think that big data is a race, but I think that will be a big part of what they go for as well.
Steve Pomeranz: My guest is Michael Brush. He publishes the newsletter “Brush Up On Stock,” which can be found on uponstocks.com, and he writes for the website MarketWatch. Michael, you mentioned the fact that American Express has this opportunity in big data. It’s an interesting point because many or most of their competitors don’t actually have or own the client data, they’re kind of intermediaries, if you think of MasterCard or Visa. American Express has their own database, is that correct?
Michael Brush: Yeah, it’s really complicated how credit cards work. It seems simple but it’s not. Basically, Amex has it’s own payment system end to end, right throughout the whole transaction. Whereas … You can think of it this way, credit cards, they glom on to a system and they see a piece of it. They see a piece of it, but not the whole transaction train from end to end. Amex has that, and that gives them more information on customers, and they will be able to work that to develop relationships, not only with customers but also with merchants. They have a lot of room to grow in the small and medium merchant area. If you think of where you can’t use your Amex card, it’s often really small companies, medium merchants. That’ll be a plus, right?
Steve Pomeranz: The bottom line is that any way that American Express can bring value to the merchants that is over and above what a MasterCard or Visa can do, and whether it’s by providing that merchant with better data, better pricing, or whatever it may be … I guess the bottom line is, and again we’re not making any predictions here, but in the case of a lot of these companies, and I’m thinking about McDonalds right now. They were basically suffering from the competition of a lot of new fast food places that sprung up, Chipotle being one of them, Panera Bread, and so many others. They kind of lost their way. They had too many products. They had developed kind of a tin ear to the marketplace to a certain degree. They let go the people who were managing that, they brought in good people. They have a lot of money to attract the best people, and, eventually, not all the time, but there’s a good chance that companies of this size with these kinds of resources can turn the ship around. Any final words?
Michael Brush: That’s right, and you know McDonalds is a good example. They were really despised, and they got the message, and they’ve tweaked their product line and done pretty well.
Steve Pomeranz: To find out more about Michael Brush go to his stock newsletter uponstocks.com.
Michael Brush has been my guest talking about all things stocks today. Thanks for joining us, Michael.
Michael Brush: Okay, thanks for having me.