I spend a lot of time thinking about my actions trying to determine if I made the right or wrong decision and if I made wrong decision, what lesson I need to take from the experience to apply to future endeavors. So of course one of the questions I asked myself is did I sell too early?

One thing I try to remind myself of in situations like this is “What the market does after you open or close a position really has no bearing on the quality of your decision.” While I would like to take credit for that thought, I imagine it was probably inspired by something I read from someone much wiser and with more experience under their belt. In essence what I am trying to say is that especially in the short term you should not use the market to judge your decisions. Even though the market values VVTV at over $7 and IGOI at over $4, that is not an indication on the quality of my decision to sell at cheaper prices.

Why? The answer really boils down to my investment philosophy. I started investing because I felt I strongly identified with the value investing framework. It makes sense to me and I feel confident that if applied with discipline it can lead to superior performance. While there are many interpretations of the value investing framework, one of the core tenets of value investing is the “Margin of Safety”. Buffett’s early investment style was influenced by his mentor Ben Graham. His style today is probably influenced by many people, two of which are Phil Fisher and his long time partner at Berkshire Charlie Munger. As his style has evolved the margin of safety is still a key component.

I entered both of these positions because I felt they provided adequate margins of safety trading at good discounts to their liquidation value and in both cases the companies had the chance turn around their business as an ongoing concern. So far they have both been making good progress and the market is treating them nicely for that progress. However lets not forget that these are not fantastic businesses with strong moats. So in my case, I bought them at discount to their value dead and got a premium because things worked out well. If only all situations could work out that way!

Both of these companies have a chance of success however once the margin of safety is gone there is nothing to backstop the value. Both of these companies have to execute with little or no error to continue on the upward path they are on. In this case the value the market puts on their progress is of no concern to me, what is of concern is the companies strength and the margin of safety I have if I hold.

Buffett has said that the best businesses are ones that can be run by a ham sandwich, because someday a ham sandwich will run them. I did not enter these positions because of their great business, I entered them because the market was selling them a large discount. They were Graham style cigar butts.

In the event that they enjoy great success long term the shares will appreciate accordingly, however in the event that they fail there is a higher risk of capital loss than I am comfortable with. Unlike companies with strong moats they can’t afford to make mistakes for a year or two. They must do a lot of things right.

So in conclusion when thinking about selling stocks do not think about the market. Think about the business and the margin of safety it offers at its current price. If you do that you will probably be right more often than you are wrong.

Disclosure: No positions in the stocks mentioned in this article.

• 16.55% Biglari Holdings (BH) – This a combination of SNS stock I purchased in between $10-$15 per share (pre reverse split) and stock I received from the WEST transaction. Performance here has been great, although I really struggle with what I will call the “shenanigans” of Sardar Biglari and what appears to be his obsession with BRK fast track, except of course on the CEO compensation front. I have recently thought about exiting or at least reducing exposure here, but I have been defaulting to “Lethargy, bordering on sloth”.
• 14.11% Istar Financial Preferred Series G (SFI-G) – Istar is a distressed REIT focused on commercial real estate lending. I also own a common position (SFI) in addition to these preferred shares, but 14.11% represents just the prefs. Istar ran into trouble because of NPLs. I bought these when the company was almost left for dead ($2-$5 per share) during the peak of the market panic. To date they have kept paying the dividend and they have been slowly but surely digging themselves out the hole they are in. I expect 2011 to be a big year for Istar but I have to monitor this position closely as things could change pretty quick. Par on these is $25, so at 18 today the upside is getting smaller but the yield has been great. Dividends on this position have pretty much covered my cost basis.
• 11.8% Premier Exhibitions (PRXI) Like BH, I think PRXI needs no introduction in value investing blogging community. I entered PRXI around January of 2010, currently up almost 50% on this position. With PRXI, you either believe the Titanic assets are undervalued or you don’t. I fall in the former camp. If the PPS gets over $2 I will start thinking about selling.
• 11.54% Contango Oil and Gas(MCF) I once told someone that if Kenneth Peak ran a toothpick manufacturer I would buy stock in it. While thats a little bit of an exaggeration, its not far from the truth. I own MCF not because I have some thoughts about the movement of natural gas prices, but because MCF is very well run low cost producer with a great track record for creating value.
• 9.84% Labranche & Co. (LAB) Labranche is financial firm that has been around forever but has seen much better days. It is worth more dead than alive, I suspect in 2011 we will see something happen here that will return a value to shareholders higher than today’s prices. My guess is going private or winding down the business. In the interim the discount to cash and investments, the high insider ownership, and the ability for the company to buy back shares on the cheap is what keeps me hanging out here. I consider this heads I win,  tails I don’t loose much scenario.

So there are the largest 5 positions out of 20 which makes up around 63% of my total holdings.  I don’t follow any portfolio allocation strategies so my position sizes are a result of the either the growth of a smaller position or a result of the available dry powder when I find an investment.

Location: Itex headquarters, Bellevue, WA

Attendance: 12 or 13 people including the ITEX board and company operators.

A representative of the Polonitza Group was in attendance, to see who the Polonitza Group represents view this 13D filling. The Polonitza Group among others includes David Polonitza who according to this letter has been an ITEX holder since 2004. Most of the questions were asked by The Polonitza Group. Some specific questions that were asked:

What was the reason for removing from the company by laws the ability for shareholders to call a special meeting? Is there any plan to re-instate this in the future?

They essentially said that this was done as a result of the WEST situation and at the recommendation of the counsel that was helping them during that time period. They believe it is in the interest of shareholders because it prevents management from getting blindsided with issues that have to suddenly take them away from running the business. They also noted that there processes for shareholders to voice concerns and have items brought up at the annual meeting. In addition they noted that they are always available to communicate with shareholders.

It sounded like they have no plans of reinstating the provision to call a special meeting however they did solicit feedback.

Steve White thought the bylaws were amended two years ago, but the Polonitza Group noted that this happened in the past year or at least not publicly disclosed until the past year.

I have yet to go through and track down the filling where the bylaw change is mentioned.

The Polonitza group voiced concerns over the lack of perceived independence in the board and compensation committee. As a publicly company they do not feel ITEX is doing enough to maintain proper independence on the board. They would like to see someone on the board that does not have existing relationships with the board members and they would like that entity to be a shareholder who has a reasonable position in ITEX. The Polonitza group offered up any of its members to sit on the board with no compensation required. It should also be noted that while The Polonitza Group expressed concerns about the lack of independence on the compensation committee they did state that they feel Steve White is properly compensated if not undercompensated.

The board in general tried to emphasize that while they have working relationships they are not very close friends and maintain independent thoughts and ideas.

They wanted to express that felt the board is more independent than the Polonitza Group was implying. They mentioned that while they have known each other and worked with each other for quite some time, they do not frequent each other’s houses or family events.

The Polonitza Group expressed concerns about the track record of return on capital deployed recently by ITEX. They also noted that the having an independent board member with capital allocation experience could be beneficial.

Steve mentioned that ITEX expects to see future returns on capital they have deployed.

The Polonitza Group asked if they would comment on the performance of the “SuperTrader” exchange launched by Idearc Media which is powered by ITEX.

Steve said that they are not disclosing details on this at the moment. I believe he did note that they expect it could be around 10% of revenue.

The Polonitza Group asked if the Idearc Media’s bankruptcy has any effect on deal between Idearc and ITEX, and if they expect that Idearc would attempt to renegotiate or back out.

Steve said that Idearc has been a great partner, they have always paid invoices quickly and after entering bankruptcy they had a small outstanding balance which they have assured ITEX will be paid as soon as they emerge from the bankruptcy. There was no indication that Idearc plans to renegotiate or back out of the deal.

The Polonitza Group asked if the company has thought about paying a dividend in the future.

Steve asked the shareholders for their thoughts on this. I happen to be the first one asked and was caught a little off guard. My response was that I would not opposed to the idea of returning some of the cash back to share holders, however I want to the company to maintain a strong position and be able to take advantage of opportunities to reinvest earnings at decent rates of return should opportunities become available. Most of the shareholders agreed with my statement, The Polonitza Group specifically said they were not interested in dividends being paid, specifically they pointed out the double taxation that happens when you receive dividends in taxable account, meaning the company is taxed on earnings and then the shareholder is taxed as well on the portion of earnings that gets distributed in the form a dividend.

During the dividend discussion the Polonitza Group brought up capital allocation and stated that they believe ITEX would be a good candidate for a holding company structure where the business units return free cash flow up to the parent level and the parent level manages the deployment of capital.

One shareholder asked about a $500,000 bad debt expense recorded on the balance sheet.

This was attributed to unpaid accounts receivable, Steve mentioned that they have an extremely low percentage of monies that go uncollected. I believe the number was 2%. They also mentioned that no commission gets paid until money is received. He also mentioned that franchisees are empowered to collect this money from members which attributes to the high recovery rate.

The Polonitza Group asked the board to comment on the lack of insider purchases by the board during the market turmoil which left ITEX selling at extremely cheap prices.

The board gave some reasons for not buying, Eric Best said he was very tied up in his startup “Mercent”, and was not necessarily financially comfortable or able to deploy cash for stock purchases during these times. Steve commented that he already has a large position in ITEX and stock purchases generally don’t cross his mind. Another board member pointed out that no one on the board has sold any stock in years. The Polonitza Group pointed out that Eric was the last to sell, Steve pointed out that he bought the shares Eric sold.

The Polonitza Group said that they understand people have personal reasons for not buying stocks during this time period, but they noted that even some smaller purchase by the board would go a long way. I pointed out that when ITEX was selling at bargain basement prices and no insiders were buying this is generally interpreted in a negative light because people will often take this as a sign that management does not think the stock is a good deal.

The Polonitza Group expressed that they felt ITEX should have been buying back stock when the stock was cheap and said they felt stock buy backs would yield better returns then their acquisitions.

Steve mentioned that they have the ability to buy back stock without the need for seeking approval, I believe the number was up to 2 million but I can’t be certain. Steve mentioned that thought it might be better to leave stock in the market for investors who want to buy more ITEX instead of reducing the liquidity of the stock and making it less available.

One of the ITEX folks, not sure if he a board member or the CFO mentioned that he has tried to find compelling evidence that stock buy backs provide any benefit or value to shareholders and he said most reports he found say they do not work. Myself and the Polonitza group both commented on the fact that most companies buy back stock at a price that is too high to provide value to their shareholders. It should be a very simple exercise for them to determine at what prices they should consider buying back stock.

That’s all I can remember for now. If I think of anything else I will update it.

Disclosure:
I own ITEX stock at the time of this writing.

In his presentation he referenced some stats from a Blackstar Funds paper on the Russell 3000 index between years 1983-2006.

Russell 3000 stats 1983-2006

39% of stocks were unprofitable investments

18.5% of stocks lost at least 75% of their value

64% of stocks underperformed the Russell 3000

25% of stocks were responsible for all of the market’s gains

Well obviously an enterprising investor after reading this would be diligently researching looking for the %25. If you only invest in those companies you are sure to outperform the market. Well not always…

What a difference a day makes

The paper also gives us a sampling of some of the best performing stocks during that time period and their performance after the peak:

Thoughts

It would be interesting to see of the %25 that made up %100 of the gain in 1983-2006, how many companies would still be worth owning today. Looking at that list there are a couple. Of course there are some that would have resulted in a permanent loss of capital and some that are not permanent losses yet but for which the immediate future is not bright. Lets take a quick look at a couple…

GE

If you had bought GE on 01/03/83 at its closing price of 91.75, split adjusted (48:1) each share would be worth around $670 today. I figure thats about %8.3 compounded annual gain. If you had sold that share before the market drop you would have approximately 3x that amount somewhere around %12.5 compounded annually. Not including dividend payments. While GE is a mess today, its fair to say you could of done worse things than buying a share of GE in 1983.

MSFT

If you had bought MSFT when they went public on 03/13/86 at $28, split adjusted (288:1) each share would be worth around $8000 today. Around %29.3 compounded annually. Not including dividend payments.

Conclusion

This data reinforces a couple of points that I sometimes temporarily forget.

1. If you own a sub par company because it was undervalued when you bought it, sell it when it reaches intrinsic value and take your profit. There is no reason to hold it afterwards because it is likely to fall into the %64 that under perform the market. If you sell it and move on to the next value you will be on your way to out performing the market.

2. Paying a little bit of a premium for a a great business with a great moat and great management can pay off big time.

3. I think people should really call “buy and hold” “due diligence, buy and due diligence hold, rinse repeat”.

Lynch’s investment style varies quite a bit from the traditional super value investors. Lynch seems more likely to invest in public offerings or companies that have little operating history if he feels they have potential for serious growth. Lynch is willing to take a little risk on situations where there is some uncertainty so some people might call him a “growth” investor. That being said I try to ignore categorizing investors into buckets like “growth” and “value”. Instead I categorize them into two buckets “good” and “not so good”. Looking at his record Lynch falls in the “good” bucket. I can’t imagine how much work it must be to manage a fund with billions of dollars in assets, over 1000 positions and on top of it providing returns that outperform the market.

One point that Lynch makes again and again is that you should always use whatever edge you have over Wall Street. If you work in in a particular industry and have a finger on its heart beat, you have an edge over people sitting in front of a Bloomberg terminal all day who may invest or trade in that sector. In the book Lynch mentions examples of great companies that he identified before Wall Street simply by being a typical consumer. Lynch also mentions some of his follies, such as the sandwich shop he ate lunch at that made a public offering. He bought in because he felt he had an edge on predicting the success of their business. They found out the hard way that their sandwich shop format did not go over well in other cities as the expense of the shareholders who bought the stock offering.

I walked away from Lynch’s book thinking primarily about one thing. What unconventional research tools are available to investors? When I say unconventional I mean anything that gives you information a typical investor or money manager might not get from the annual reports or SEC filings. Here are a few examples of some unconventional and some more conventional but under utilized tools that might help give you an edge.

The Phone

This is not really unconventional, but I think underutilized. I personally have not exercised this option as much as I would like to but I think after reading Lynch’s book I probably will.

Email

Same the idea here. There was a risk arbitrage situation I was interested in and I was trying to get a little more information about when the company expected to complete the transaction. I emailed investor relations at the company supposedly making the purchase and my email to their investor relations address bounced because the person who answered that address was no longer with the company. While this doesn’t give me any information about the merger it could be an indication of how much or little effort they put into informing shareholders. On the flip side I have emailed investor relations at other companies and gotten immediate responses from an actual human being, sometimes with decent answers to my questions! That is always a good sign.

Web stats

In my previous post about IGOI I mentioned that I went to a local retailer to see what their in store marketing and placement looked like. Another bit of research I did was related to their online store. In their conference call from last quarter the CEO mentioned that they are engaging in a more direct to customer marketing campaign. They launched a new online store where customers can buy product directly from the company cutting out the middle man and resulting in higher margins for IGO. When I heard that I decided to go to Alexa and see what they said about traffic going to the IGO website.

Here is what they had to say:

The one thing this tells me is that traffic to their online store is not growing. For a company attempting to reach customers directly I don’t find this encouraging. Another thing I looked at is their online advertising. If I do a google search for IGO, I see an sponsored link for IGO’s website. They are paying to show advertisements for people who search for “igo” even though their site is the first organic (non advertisement) search result. Now if I do a search for “universal laptop power supply” I don’t see an ad for IGO. I refresh a couple of times, still no IGO ad. This makes me wonder if they have a handle on their online advertising campaign. Next I do a search for “netbook power supply” and first time I don’t see an IGO ad, I refresh and I start seeing their ads. At least they are going after netbook customers, but I still get the feeling that if they are really trying to reach more customers directly their online advertising strategy might need some refinement. Any one of these things on their own don’t provide a ton of data, but as you start to add them up you can start to draw a picture of how well the company is aligned with their mission. It is possible that they are just gearing up their online business, in which case now that I have this information I can monitor it accordingly and this can give me an edge on how the company is doing. We already know that they are loosing their biggest customer (Targus) and they need to make revenue up some where. If their Alexa stats start growing this might be an indication that they are on the right track.

Street View

In some cases Google Street View can be a good tool for checking out the company headquarters of smaller companies. Is it a fancy building? Is it a dump? Does it even exist? Unfortunately street view only works in major US cities and this information in a lot of cases could be of minimal use, but you never know what you may find.

Here is the Vaxgen (VXGN) office (I liquidation situation I had a position in):

View Larger Map

Here is a Berkshire Hathaway in Omaha, Nebraska:

View Larger Map

LinkedIn

LinkedIn is a professional social network. Facebook for corporate America. One of the ideas I had for LinkedIn was using it as a tool research company management. If a CEO or other executive is on LinkedIn there is a good chance his or her employment history is on their profile. Are their previous companies still around or did they run them into the ground? This could be a good starting point for finding out more about executives in small companies.

Obviously these tools on their own will not tell you what stocks to buy or sell. However they can potentially provide some value when used in conjunction with your normal investment research.

I initially learned about IGO from an excellent post on OldSchoolValue.com. At the time it was trading below its liquidation value making it a cigar butt with at least one good puff left as long as the management did not blow all the cash. The management has shown good signs of cost containment and even increased it cash position despite dwindling revenues.

I bought IGOI at $0.58 and while it has traded above my cost basis for the majority of the time I held it, it recently jumped up as high $1.30. Looking at almost %120 gain in 6 months I decided to reevaluate my position and see if I should continue to hold to this company now that it’s trading at a premium to what I believe to be its liquidation value.

I decided to evaluate the pros, cons and facts: