Buy High, Sell Low (FARO)

Well, sometimes three weeks makes a big difference. I spent a fair amount of time reconsidering FARO Technologies (FARO -- click to register for free RT streaming quote) back in December, and then early in January I decided that I would hold on and hope that my assessment of management and of their ongoing business prospects was correct.

Those of you who watch the company or can see the little chart on the right will note that it fell dramatically on Friday on a shocking revision to their earnings guidance, and if you've watched the company for more than a month or so you'll note that this isn't a first. It's been a bad year to be a FARO owner.

Their ongoing business prospects may still be fine, and, frankly, I think their market is still pretty good ... but I have now really lost faith in management, and whenever that happens a little red "sell" flag flies across my mind.

So today I sold FARO at a significant loss -- I had bought early last year at an average price of about $27, and sold today at $14.98.

Ouch.

There are few things that are constant about me as an investor, I've found. One of them is that I have tried with some success to be extremely patient about selling, whether it's to lock in gains or get rid of losing positions -- and for the most part, that works out. But it definitely didn't work this time -- in retrospect, my initial fears for Faro were correct, and my more rational calculation at a later date was wrong. Of course, there was no way to know that at the time.

My experience with Design Within Reach (DWRI-- click to register for free RT streaming quote) another flop of an investment that I sold recently, was pretty similar -- in both cases, management seemed to lose control of the company and failed completely to communicate effectively with investors. DWRI is a much worse company than FARO in other ways, in my opinion, but the problems with management followed a similar track over the course of the past six months or so. Maybe both of those companies will recover and be great investments over the next few years, but it seems a bad bet to me.

I think holding on to companies that you believe have a bright future is still the right way to go, even if their value has gotten ahead of them or they've had some bad news impact their stock price. But even if that's the right way for me to invest most of the time, it sure backfired here.

So fare thee well, FARO. I had high hopes, but it no longer seems like management has enough control over the company's growth, expenses or operations -- being this far off on your estimates isn't acceptable, especially when it happens a few times in a row and management is engaged in selling a significant portion of their shares. There are too many fish in the sea to hold on to this one.

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Annual Checkup -- FARO

FARO Technologies (FARO -- click to register for free RT streaming quote) has had a tough year. I wrote about how I put them in the dog house about a month ago, and then a couple weeks later did some more research, reconsidered, and decided to hold on. My shares of FARO were purchased at an average cost of $27 so I did have the opportunity to take a tax loss on them if I wanted to, but it didn't make sense to do so at the time. I have become convinced that management is focused on the important things for fixing their business, and that their problems over the past year have been related to their sales force rollout, management of the product mix, and rampup and their inventory management and Street guidance -- the actual business environment, demand for their products, and their prospects for success seem to still be quite good. I will be watching management, and I hope they were wise and returned to their former policy of being extremely conservative in their guidance for next year, which is very low, but I like their business niche and I think they've set themselves up to have some great long term growth due to their investments in inventory management, sales force training and distribution, and executive humility this year. I will not be pouncing on any bad news to look for a reason to sell, but neither am I interested in adding any more at this point -- I'm comfortable with my full position in FARO and look forward to seeing how they do in the next few years.

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Reconsidering Faro Technologies (FARO)

I wrote a few weeks ago that I was putting FARO in the doghouse. Well, today I think I'll let him run around the yard a little more -- I've looked into their business a little further, and I'm not as concerned as I was initially over the erosion of their business and their difficulties in providing guidance.

It cannot be denied that Faro Technologies' stock (FARO -- free real time quote from ADVFN) has had a bad twelve months. The company ramped up to very fast growth over the past couple of years and really stalled this year. Earnings during the first half of the year deteriorated significantly from what was expected, and management's stubborn insistence that they could hit their annual targets seems, in retrospect, to have been very unfortunate indeed.

I've spend some time in the last few weeks revisiting my investment in FARO and reconsidering whether or not I still feel comfortable with the company as a long term investment. I found out about FARO from the Motley Fool originally, and they've been following this disappointing year pretty well -- the most recent article of significance was quite negative, with one of the Fools selling on December 1.

So should I hold?

I think so. After carefully reading the conference call transcript from the third quarter, which is when they finally realized they couldn't come close to meeting their guided numbers for this year and would have to guide down next year as well, I have a lot more confidence in the viability of the company as a continuing growth investment for the long term.

And after listening to a good interview with Simon Raab, the CEO, that the Fool released as a podcast a few weeks ago, I remain pretty confident that the CEO has the best interests of shareholders at heart and has learned his lesson about the provision of guidance (ie -- don't give guidance if you don't have to, and if you must, guide conservatively).

So what were FARO's problems this year, and why do I feel confident going forward?

The problems were several -- but I think there were two major ones that led to the problems with guidance.

First, the company failed to predict very well the way that their much broader product mix would sell this year. They now have three major sales vehicles in the Faro Arm and Gage, the Laser Tracker, and the Laser Scanner (that last one being the major contribution of their purchase of IQvolution). Management was a bit surprised by the mix of sales that went to the lower-margin products like the Gage and the Laser Tracker this year, and they were also caught flat footed by sharply lower European sales and the fact that seasonal patterns in their sales didn't follow the usual back-loaded trend this year (at least, not in the third quarter).

And second, the company had significant problems with inventory management and timely order fulfillment.

The problems with product mix are not going to work themselves out -- and it's arguable that it's even a problem, as long as management acts a little more conservatively in the future. I definitely got a strong sense from Raab that the sales underperformance was unacceptable, however, and they're really refocusing their European sales force to get those sales back in line.

The problems with fulfillment and inventory are going to be worked out, or at least they are being worked on significantly. The Singapore headquarters for Asian sales is now opening and should be able to much better serve their fastest growing markets, which will help them to manage their fulfillment better. And FARO has spent the last several months implementing a new inventory management solution that they believe will solve their problems.

Much of my assessment is personal. I am disappointed that the growth reached this "hiccup" point this year, especially since my average cost for my FARO holdings is around $27 and is well under water.

But I remain quite impressed with the management team and their resolve to fix the problems that surfaced this year and to be much more conservative in promising future growth.

And as importantly, I don't think that we can ascribe FARO's recent problems to a saturation of the marketplace. I think this computer aided measuring and manufacturing area is still ripe for dramatic growth over the very long term -- while automation is certainly no new thing in the world of manufacturing, this kind of computerized and precisely automated measurement and control is still very much underutlized. FARO believes they have only reached a small piece of the market, and I'm inclined to agree with them.

There are certainly still plenty of risks out there for FARO.

I could be wrong about management, and Raab might be angling for a way out. I don't think so, and even after his controversial sales this year he is still by far the major owner, but it's certainly a risk.

FARO's competition might catch up and take leadership from them while the business is still relatively in its infancy. FARO is fighting to hold its patents and keep its customers, but I can't tell from here whether or not they'll succeed.

Stock price wise, the Hidden Gems newsletter service at the Fool might recommend selling FARO (or maybe they already have, I don't know) -- I imagine that might significantly impact the stock price in the short term, at least.

FARO might be further from turning around its sales and inventory issues than I think they are, and another tough year would be hard to take.

And finally, FARO has a very diversified base of customers but they are also quite focused on a few specific sectors -- heavy manufacturing, aerospace, and automotive manufacturing make up a large part of their customer base. They might continue to be able to drive sales to these industries even if they hit hard times because of the ROI argument that FARO can make for their products (they're still selling well to GM right now, according to Raab), but there's certainly a risk in their reliance on these cyclical industries.

I've decided to accept those risks for now and hold my FARO stock -- I think in a few years they'll be much stronger than they appear right now. I'll let you know if I change my mind.

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FARO in the doghouse

I've been an owner of FARO since January, with an average purchase price of about $27. Needless to say it hasn't been terribly pleasant watching this once highflying stock fall into disrepair this past Spring and Summer. I was a lot more optimistic about them in July, as I wrote about maybe trying to catch a falling knife, but things didn't turn around as I thought they might and I'm a little more concerned today.

This was a stock that came to my attention courtesy of Hidden Gems over at the Fool, though I no longer subscribe to that newsletter and am not privy to their current thoughts on it. Another Fool writer just wrote an interesting piece about selling FARO today, which brought it back out from the back of my brain where it had been stewing. I'm not necessarily giving up on Simon Raab and his cohort, but there's definitely concern in the air.

From outside, this looks like a situation where the founding science guys of a technology company had trouble with the business and competition side of things -- and especially with the job of managing market expectations. I don't know if that's a fair assessment, it's just my impression. Everything I've read tells me that the FARO arm is a significant tool with a great market and with a market leadership position in both sales and technology. And hey, Boeing just ordered a bunch more of them and they have a very deep and wide installed base of users and broad potential applications. That's the good news.

But everything I read lately tells me that this management is worrisome. Read the Fool piece above for a better take on this, but the basic gist is that Raab planned to ease out of his ownership position through a scheduled selling plan -- which is fine. But before it started to appear to outside investors that the wheels were coming off the bus, he accelerated that plan significantly and was able to sell at much better prices than we're seeing today.

I'm willing to give him some benefit of the doubt. I don't mind when founders and major insiders sell some of their holdings -- that's why you go public, after all, to make your fortune from the company you built. But given the fact that FARO was until their last earnings announcement still holding to an unrealistic earnings forecast for this year, It stinks of management propping up the stock price just long enough to get their own shares sold.

I certainly don't know that that's what they were doing -- but it definitely looks bad.

Just as I buy in chunks -- usually taking two or three purchases to build up a full position in a company -- so I often prefer to sell in chunks, too, and I'm going to look into FARO in much more detail to see whether it makes sense to sell a portion of my FARO holdings before the end of the year to offset some of my taxable gains. I'll let you know what I decide -- and if you're a FARO owner, too, let me know what you think.

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Catch a falling knife?

Days like this are what makes me wish I had more cash on hand, while at the same time making me fearful of what I would do if I did.

The old stock market adage, "never try to catch a falling knife," is an apt one -- articles from various folks on just this topic are here and here -- but unfortunately, the urge to try is one of my weakest characteristics as an investor. Two cases in point today:

Shanda (SNDA), which I've written about before and which is one of my favorite Chinese companies, is falling for reasons I can't easily discern, and after climbing up above $40 for a little while after I purchased it it has now fallen down to near my original purchase price of $32. And that's in just a little less than two months. Business seems to be good, earnings should be quite strong when they're released, and the valuation makes it quite a bargain in my opinion -- forward PE of 16 for a company that's expected to have AT LEAST 30% annual growth going forward?

This one is always pretty volatile, so a 20% move over two months may not be a big deal, but it gets me itching to buy when it drops this far and I don't see a good reason for the drop -- although politics and competition are certainly always threats, SNDA is still the biggest force in the market and Chen Tianqiao is an icon of Chinese success. But I have to keep reminding myself, let it fall and watch for a while, don't buy just because it's cheaper than it used to be. Reconsider the fundamentals. Try to figure out why it's falling. Wait and see whether someone knows something you don't know. But also don't necessarily believe ridiculous claims like this one that "Shanda should do well because Microsoft and Marvel both also think massively multiplayer online games are a good idea."

And the other one that's collapsing as I type this is FARO technologies (FARO). This is a great company, in my opinion, with a spectacular product and very strong management. I first found out about them when they were a Motley Fool Hidden Gems recommendation back when I subscribed to that newsletter, and I really like the story. I have a full position already, but the hiccup in quarterly sales that they just announced has dropped the shares by about 14% last time I checked -- I want more!

FARO basically designs and sells computer aided design and measuring equipment -- notably the FARO arm, their signature product that allows extremely precise laser guided 3d measurement. They sell all over the world, and are even planning to build manufacturing capacity in Asia to meet the rising demand for their products there. Boeing just ordered 10 of the Arms, which was released along with the sales press release as perhaps a way to soften the blow.

This is one where I really might try to catch the knife, since it really appears to me as though they are falling just becauase of a little softness in the quarterly sales -- they still have a solid backlog of orders, and they have not changed their annual guidance (though this sure makes it tougher to make the annual numbers, as Bill Mann at the Fool wrote today), but some sales moved from Q2 to Q3. They are going to stop issuing these kinds of sales updates, probably with good reason, and they are going to only issue annual guidance, not quarterly, going forward. I like both of these decisions a lot.

But I am trying to be disciplined, so I am trying to wait.

You see, I've had some bad experiences. I bought Ebay when they surprised everyone this winter with bad growth numbers, just because I loved the business and thought they would come back. I ended up selling it a little while later because I thought other businesses, including Google, were more likely to grow my money.

I bought Overstock when they surprised everyone on the downside this winter as well, and I'm still holding but the chunks I bought at $58 and $53 are well underwater. I kept buying the falling knife later on, catching some in the $30s as well, so I'm close to even over all. Same with Provide Commerce -- another business I love, bought at $34 before they disappointed with Valentine's Day, then bought more as it fell at around $18. At the top of my writeup on Dreamworks Animation you'll note that I bought once before the troubles began this winter, then again after the Shrek 2 DVD problems pushed the price down to $31 ... but if I had waited, I could have picked up some today for $23. I still like the company in the long term and am holding, but I can't justify increasing my position any more even though it's now on even more of a sale (and who knows, maybe it will go down again after Wallace and Gromit this fall and I'll be tempted again).

The experts say that you should wait for a stock that's on a precipitous decline to "settle" and display a "bottom" before you buy in because it's on sale. I respect the opinion, and I understand that it comes from years of studying charts, but that smacks too much of technical analysis for me. I don't understand candlesticks or stochastics, and I never intend to, and the only bottom I really can pick out of a lineup is my own -- if I see a company go on sale that I already own or that I'm interested in, it really really really makes me want to buy in. I'll try to avoid buying the day that it falls and wait to see if the coming weeks will make it more of a bargain, but psychologically I think I'm more afraid of missing a bargain than I am of making a mistake and buying too high -- after all, these are companies that I really admire and believe in long term, so I have some faith that it will work out in the end -- especially in the case of FARO, where I think I understand why it's falling and am fairly confident that the market is overreacting.

So while I'm trying to be disciplined and wait for stable prices and the end of the decline (though if it was easy to pick the bottom, we'd all be rich), too much discipline really takes the fun out of this -- and if it's not fun why not just buy an index fund? I'll post any changes that I can't resist making to the portfolio, so all will be able to see if I'm an idiot.


Technorati tags shanda, SNDA, Chen Tianqiao, FARO, knife

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