Eddie Lampert ... just like me?

I don't want to pile on the Sears Holdings boo-fest that's happening across all financial media this morning -- but I thought I'd share a few thoughts I had about Eddie Lampert and what I think are some mistakes he might have made ... mistakes that are certainly similar to the kinds of things individual investors, myself included, do to sabotage themselves every day.

What we have seen from Sears Holdings (SHLD), Eddie Lampert's primary holding and the stock that was supposed to be his investment vehicle as he built a Warren Buffett-like empire, has been nothing short of dismal. The shares are now about 50% below the high that they hit back in May, primarily because the actual Sears and Kmart stores are doing terribly -- weak sales, weak earnings, and, frankly, stores that no one could be excited about visiting.

But you've already heard that from pundits across the globe today already -- what I was thinking about was how Eddie Lampert's experience can illuminate some of the problems that individual investors often have, problems deeply rooted in our psychology.

There are two things that I think have been significant about the Sears Holdings story since Eddie Lampert got on board. Certainly, he almost immediately increased the value of the company dramatically by harvesting the value of the real estate below the Sears and Kmart stores, and no one can take that away from him.

But in terms of operating the company, beyond that first burst of value creation, there are two things that I think are significant.

The first, is that Eddie Lampert didn't just buy Sears because he thought it had undervalued real estate, harvest that value, and move on. He thought he could turn around the company itself.

That, to me, is a bit of a warning sign. It strikes me that this is the same kind of problem that individual investors often have, they assume that their skills and expertise in one area mean that they are naturally going to be skilled and expert investors.

What do I mean? Well, Eddie Lampert is, even given this current problem at Sears, clearly a brilliant value investor. He knows how to identify bargains, he knows how to use financial engineering of all sorts to harvest value, he knows how to get great returns on the public and private markets.

Does that mean he's a guy who can turn around a struggling retail giant? That's very much still an open question.

I've made similar kinds of mistakes more than once myself -- often times after I have an experience that I think validates my investing acumen, I have come across tiny stocks that seem brilliantly positioned, in areas where I have just enough knowledge to get myself in trouble, and I've invested in them. Often, it hasn't worked out, but I find myself buying those shares -- to psychoanalyze myself just a little -- because I get puffed up by a successful trade or investment and think, "I'm brilliant! If I like this new stock it must be great!"

I'm not saying that Eddie Lampert is nearly as swayed by emotion as the typical investor, or that he's as much of an idiot as I've proven to be at times ... but it continues to look to me like his belief that he could bring any kind of operating savvy to Sears, and manage the stores in a different way without worrying about standard metrics like same store sales growth, might have been a bit of hubris. He's a brilliant guy, by all accounts a strong-willed guy who has been able to bend many situations to his will -- he negotiated his own release from kidnappers, for crying out loud -- but that doesn't necessarily mean that his ideas for managing a retail dinosaur are going to work.

This psychological problem in individual investors has generally been described as "overconfidence" -- it's possible that other issues are coming into play for Eddie Lampert as well, like "cognitive dissonance," which as I think of it is the inability to process conflicting information -- in this case, his close relationship with Sears, his heavy investment in the company and it's future, and the confidence that he has the right plan makes him unable to see the skeletons of Montgomery Ward, Jamesway or Ames and realize how difficult (I'd say "doomed") his challenge is, especially with a weakening consumer market.

The other significant psychological barrier that Lampert seems to me to be running into, and again it's one that's quite common for me, is simple obstinacy. This is related a bit to cognitive dissonance, in that you want to stay on the same track with what you feel should be working, and you ignore warning signs that you're going the wrong way.

In my case, this would be akin doubling down on falling stocks because I still keep in my head the original conviction I had that they would be excellent investments -- one example of this is Chico's (CHS), I bought shares ages ago, at much higher prices, and averaged down a few times because I believed that the problems they were having were temporary. If so, they were "long term" temporary and they continue to worsen -- so in my case, I built an image of Chico's in my mind that said it was a strong grower for the long term ... and even though that growth case started breaking down, with plenty of evidence for that breakdown coming out every quarter, or sometimes every month, I kept putting more in. Ooops. Now I'm stuck with the evidence of my mistake in my portfolio every day.

When we talk about Sears and Eddie Lampert, I wonder whether something similar is coming into play, particularly with his aggressive share buybacks --all of which, in the past year, have clearly now been very badly timed. While Sears has been doing badly by all traditional metrics, it has been generating some very good cash flow ... and one of the things that Lampert was supposed to bring to the table was an ability to reinvest that cash flow into much better growth opportunities. That's what made his running Sears a great idea, his ability to allocate cash flow for better long term results.

And that's what made people say that he would be the "next Warren Buffett" or that Sears Holdings would be the "next Berkshire Hathaway." Looking back on his history, it's clear that Warren is an excellent allocator of capital and a great investor, but there isn't much evidence that he is great at running a textile mill (which is what Berkshire was when he bought it). His brilliance was not his ability to turn around a dinosaur in a dying industry, it was to (eventually) realize that the textile business was dying, harvest as much cash from it as he could, and move that money into something much more valuable -- in his case, insurance companies.

And this is where I really have a problem with Sears and the current Eddie Lampert plan, at least as I interpret it. While their recent offer to buy Restoration Hardware is intriguing, the fact remains that, so far, all of Sears' excess cash has been reinvested in Sears shares through very aggressive stock buybacks. And that investment by Lampert has been a massive money loser over the past year as Sears shares have crumbled.

So, does he really have a plan to really harvest the value of Sears, or is he continuing obstinately to believe that he can restore it to it's former glory as the leading retailer in the country? Or is it something in between? I'd be happy to hire him to chop up a dying firm and get the most money possible from it, but I'd be very reluctant to hire him to turn around a complex operating business -- even experts in the retail turnaround field, like Julian Day (who incidentally made his reputation at Kmart, now a part of Sears Holdings) don't necessarily find fast or certain success in doing this every time, and in Day's case the jury is still out on Radio Shack after about a year and a half of his turnaround leadership.

I find it refreshing that Eddie Lampert seems, at least on the surface, to face some of the same psychological barriers as I do in investing -- and I hope that I can think of the plight of Sears the next time I'm talking myself into doing something foolish in a situation that I don't fully understand.

Just to close this out on a friendlier note, it is very possible that the Eddie Lampert brilliance is poised inside the moldering shell of Sears, just waiting to pounce out. I don't know what their plans are, or how they will do in the future -- and I do understand that as a long term investor in a very short term world there are going to be times that Lampert looks foolish and takes unwarranted criticism, just as Warren Buffett has on many times when he's at least temporarily on the wrong side of a trend (as with his USG purchases most recently). I might be guilty of that here.

Value investors and contrarians are often portrayed as foolish by the investing punditocracy because of the short term movements of their portfolio as they try to envision a success that may be five or ten years away, so what look like mistakes might appear better in the future. For the sake of the investors who put their faith in Eddie Lampert to built the next great value investing empire, I certainly hope that's the case here.

full disclosure: I do own shares of CHS as of this writing (unfortunately), but not of any other stock mentioned.

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Lampert Tends One Big Egg (SHLD)

I owned a few shares of Sears Holdings a couple years ago, and sold them at more or less the same price they're going for today. I didn't make much money on them, but more or less broke even because I reconsidered my investment thesis in Sears and decided that I had already missed the Kmart/Sears real-estate fueled run. In retrospect, I missed a nice run over the ensuing year or so before the shares fell back down to their current levels.

That remarkable run of a few years back, when Lampert re-engineered Kmart and monetized its real estate holdings, and used it to merge with Sears, made many people rich -- Martin Whitman at Third Avenue famously bet big on the company, and did extremely well.

But over the last year or two, Whitman's various funds started hedging their bets -- buying options to lock in their outsize profits, and in some cases gradually paring their holdings of SHLD. I don't know that they had a fundamental reason for doing this, other than the fact that the shares no longer met their "safe and cheap" criteria -- I don't think, for example, that they sold because they questioned Sears' ability to merchandise effectively under Lampert.

That last bit was my main concern when I sold -- I feared that I had missed the real-estate fueled run, and that any success at Sears was going to have to come from actual performance of the stores. Lampert's focus on profitability and cost cutting was clearly making the stores look lousy, though it might work in the end, and it was severely derailing any progress in the oft-watched "same store sales" metric.

So it was with some interest that I read the excellent Barron's story on Eddie Lampert and Sears over the weekend -- they made clear that there is significant potential in Sears for two reasons: A recovery is possible in the stores themselves, and there is still significant unrealized real estate and other breakup value, particularly for the Sears brand.

Now that may or may not be true, but this made me think back to why many people were arguing for an investment in Sears Holdings back in 2004 and 2005: Eddie Lampert was going to be the next Warren Buffett, and Kmart/Sears was going to be his Berkshire Hathaway.

The argument was something like this: Just as Buffett took the cash flow from a failing textile mill to jump start his investment partnership, so Lampert will take the still-prodigious cash flow of a fading retailer, Sears, and use his investing wizardry to build a holding company that will boast outsize returns for generations.

There's a certain logic there -- If you were to break up Sears and sell off the valuable things the company owns, including real estate, brand names, profitable divisions, and the like, several analysts argue that the sum of the parts is valuable -- maybe even worth up to $300, according to Barron's.

But as far as I've seen, Lampert is showing no signs of doing that -- instead, it looks, from the outside, as though he's trying to rebuild Sears stores on the cheap and restore some of the chains' lost glory. I have no idea whether or not he will succeed -- and I'm not particularly a fan of shopping in Sears, except when the occasional need for a refrigerator arises.

That still may be the secret plan, of course, and maybe that's why SHLD is undergoing so many buybacks -- maybe Lampert is really planning a big value-creation storm at some point. Whether or not he does manage this, however, I think it's important to note that virtually all of Lampert's focus and the Sears cash is going into this effort. For those who were hoping that buying shares of Sears would give them access to Lampert's ESL investments, since he has been given broad authority to reinvest Sears' capital, I think there's bound to be some disappointment.

Why? Because reinvesting in Sears is pretty much all Lampert is focusing on right now. Maybe that's a great thing, but for those who thought he would mine this old line retailer for cash and use that cash to make other brilliant investments and build a conglomerate, you're out of luck so far. Sears has shown through their repeated, massive share buybacks that what Lampert really wants to invest in now is ... more Sears.

So, it might be a smart investment -- Barron's makes a pretty good bull case, which is why the shares are up a few percentage points today (though down significantly over the last year or so). But it's not the investment I thought people were looking for three years ago.

I can't be taken seriously when I second guess ESL, I don't have the cash or the investing chops to go against a clearly brilliant investor. But I don't have to believe that he's right all the time, either, and it seems to me that there's at least some possibility here that what Lampert is doing is throwing more good money after a retail chain that I personally believe is destined to fail. Is the contrarian who insists on cutting advertising, sacrificing sales growth, and letting dingy stores fester going to turn the company around?

As I look back at the history of Berkshire Hathaway, I'm wondering if this would be like Warren Buffett continuing to invest in his failing textile mill, throwing more and more money at it and not having the cash available, a few years later, to buy the truly transformative GEICO business that really put Berkshire Hathaway on easy street.

Just a thought. I might be wrong -- and for those who argue that Lampert will financially engineer great things for Sears in the years to come, through breakups or asset sales, there is something to back up that argument as well: If Lampert really wanted to rebuild the storied Sears name, he might allow the company to invest in its own future, not its own stock.

full disclosure: I do own shares of Berkshire Hathaway, and have positions in two Third Avenue mutual funds, but do not own any other company mentioned here.

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The Next Berkshire Hathaway? (MKL, SHLD, BRKB, WTM, FFH, LUK, BAM)

There are few things more entertaining or evergreen in stock investing than the search for the next Berkshire Hathaway (BRKB) and the next Warren Buffett -- with Berkshire having a nice renaissance in the last few months (up 20% or so) as they make headlines for breaking the $100,000 mark, I decided to check in on the search again.

Jim Cramer thinks he's found the next Warren (though he's far from the first to say so) in hedge fund whiz-kid turned Sears Holdings (SHLD) Chairman Eddie Lampert ... and many folks have identified other candidates, from Prem Watsa (at one time known as the "Canadian Warren Buffett") up at Fairfax Financial (FFH), to the guys at Markel (MKL). I've argued that Markel seems very Berkshire-like in the way they do business and conduct their conference calls (though having such a call is not very Berkshire-like), but they're definitely not the only ones.

Cramer is friends with Eddie Lampert and has talked about him for years, which may be coloring his assessment, but it's also a pretty nice, tidy argument to make. Warren Buffett started with a successful investment portfolio of moderate size, took over a failing company in Berkshire (a textile mill, if I remember correctly), diversified into a high-cash flow business (insurance -- most profitably GEICO), and figured out how to use insurance float and a contrarian bent to magnify his investing acumen.

Just as an aside, Cramer has also argued that Google and Goldman Sachs are good "next Berkshire" companies -- though presumably more for their high-dollar price points and growth potential than for any likelihood that they'll become investing conglomerates or holding companies.

Eddie Lampert is certainly, for a young man, a dramatically successful investor -- his ESL Investments hedge fund is generally admired for tremendous returns, and he certainly does follow some of the same contrarian investing principles as Buffett, though he has tended to be an activist investor rather than a buyer of entire companies ... and in my opinion, he has focused more on financial efficiency and on unlocking value than on building companies with great operating performance. To be fair, that's something like what Buffett did in his not-entirely-friendly takeover of Berkshire in the first place, so maybe my opinion is colored more by Buffett the friendly billionaire philanthropist than Buffett the aggressive young takeover investor, who probably shared many more of Eddie Lampert's current qualities.

I expect Lampert would need to focus on either ESL or Sears Holdings as his investment vehicle -- his hedge fund already has big investors like Michael Dell and David Geffen, and while SHLD probably makes up at least 2/3 of ESL Investments' holdings, it's not as if the two are the same. Buffett ended up having to drop his Buffett Partners investment vehicle to focus on Berkshire -- will Lampert do the same, or does he need to?

No one really knows what he'll do next, though speculation remains rampant that Lampert will be looking for acquisitions now that Sears appears to be stabilized (though the actual department store chain is still an awful business, as far as I can tell). As an outsider (though I did own Sears shares for a while and regrettably sold them well before the recent runup), I lke that Lampert's SHLD doesn't issue guidance and seems to be focused on the long term, but I don't like the fact that the companies he has worked with generally focus on improving near term profitability, arguably without an eye on long term business success. I think Sears will probably continue to spin out a lot of cash that Lampert may use effectively, but I question the staying power of the Sears stores and wonder if he's just milking a dying cow. I could easily be wrong on that.

Markel (MKL), as I've written before, seems to be following a very similar tack to Berkshire Hathaway -- albeit skipping the first few steps of buying the failing textile mill, etc., and instead moving straight into the lucrative insurance business. One of the things that stands out for me, aside from the great performance from their insurance lines during this nice rebound year for the insurers, is that management really SOUNDS like Warren Buffett in their corporate releases. And with their investment in the local First Market Bank in their local VA stomping grounds, there's some speculation that they're starting to spread their wings, investment-wise, and begin investing some of their prodigious cash flow outside the stock market (even as Thomas Gayner, who runs the investments for Markel, focuses on a lot of the same conservative, boring criteria as Buffett has in making hugely successful stock investment decisions).

What are some of the other companies that might look a little like a young Berkshire?

White Mountains Insurance (WTM) comes up with some regularity, not least because Buffett has owned shares for ages. Another insurance conglomerate, with a strong investment portfolio but without the Berkshire focus on buying operating companies in other industries, White Mountains may be a great investment -- and certainly an underlooked one, with shares trading well above $500 according to the Buffett anti-split preferences. But with the aging insurance legend Jack Byrne at the helm this feels more like a current Berkshire Hathaway, Junior than a company that's likely to take it to the next level in the coming decades.

Leucadia (LUK) wins for having the most Berkshire-like website (just compare http://www.leucadia.com to http://www.berkshirehathaway.com). It's a relatively small company for all the investments and properties they own, and I'm sure there's a significant "conglomerate discount" built into these shares to compensate for the fact that anyone buying LUK shares has to understand operations as diverse as wineries, timber, telecom, and manufacturing. I believe Leucadia started as a financial company, but is no longer significantly exposed to insurance or banking as far as I can tell -- this is certainly an intriguing company for further research.

Prem Watsa at FFH seems to be too much of a lightning rod at this point for my taste -- I'd rather not buy into a company with so much legal risk, even if he has shown some promise in building an insurance holding company in Canada (and the shares may have more volatility than any other pretender to the Berkshire throne, which some folks like).

Also up North -- the former Brascan, now Brookfield Asset Management (BAM), has been hugely successful both in managing money for institutions and in building up a collection of hard assets in, among other areas, real estate, timber, and power generation, and may be able to use the recent Canadian Trust tax law changes to buy up some valuable trust assets on the cheap, not unlike Buffett's investment in MidAmerican Energy back when pipelines seemed boring ... but while the conglomerate is growing and I'm intrigued by the opportunity ahead for this company to potentially build itself into the Macquarie of North America, there's no hint of the kind of quiet under-the-radar wealth building that early Berkshire investors enjoyed.

Others that have done a great job of building conglomerates and becoming bazillionaires? The Rales brothers who built Danaher (DHR) come to mind, and I used to own shares in that company -- but given their extremely hands-on management style and focus on manufacturing this is really more like GE Junior than Berkshire Junior.

The search goes far and wide. A Motley Fool author argued that Joel Greenblatt is investing like Warren Buffett, though he doesn't run a public company that we can invest in -- so that's not exactly the same kettle of fish.

And smaller companies with intriguing holdings or misunderstood book value often get compared to Berkshire -- including PICO holdings, described here by Cheap Stocks.

There's even a small Chinese holding company that likes to say that it has a "Berkshire Hathaway model" for China (I don't know anything about this company, they seem to be some sort of a venture investment group).

But maybe we're missing the real story -- is Buffett really just the next William Jardine? Jardine Matheson (JMHLY.PK or Jardine Strategic at JSHLY.PK, both are difficult to trade) is an international conglomerate that owns pieces of everything from the Mandarin Oriental hotels to Hong Kong Land to Astra ... and some big insurance operations.

I'm still nervous about Sears Holdings, with so many people buying it because they want to ride along as Eddie Lampert invests the Sears cash flow into other companies -- but maybe that's like being nervous about Warren Buffett buying a suffering textile mill, perhaps I just need to see through my hangups about Sears and trust in Cramer and Lampert.

For my taste, right now an investment in Markel feels much more solid -- I know I'm getting a company that focuses on profitability and growth in book value while ignoring their stock price, and I know they have the built-in insurance company advantage that Buffett had of investing with other peoples' money. Leucadia is very tempting for me if I find time to really delve into their operations, but I like the potential of Markel, and Berkshire itself (especially if they become a massive dividender following Buffett's demise, as I think is quite possible), more than that of White Mountains right now.

It's a fun game, but of course we're as likely to find the next Warren Buffett today as our parents were forty years ago -- and the brilliance of Buffett was certainly not taken as gospel even back in the 1980s, when you could have bought A shares for well under $1,000. If the next Buffett is out there right now, getting his business started, we'll probably overlook him -- after all, he'll probably be a boring, small-town businessman in a cheap suit, running a snoozy business and flying under the radar.

If you're lucky enough to find a small company with steady and ethical management, a contrarian bent, a focus on building cash flow, and a distaste for quarterly stock market performance metrics, it may be worth a shot -- especially if no one is calling it the next Berkshire Hathaway, and especially if your broker thinks you're crazy for asking about it.

Disclosure: as of this writing I own shares in Markel and Berkshire Hathaway.

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Sold Softer Side of Sears (SHLD)

Sold my shares of Sears Holdings (SHLD) today at $136.93, for a small loss [correction -- just looked back at my records. This is actually basically a break-even transaction. I had bought on May 13, 2005 for $136.24. Still technically a small loss with commissions and margin interest payments]. This is a little unusual for me, as I'd held the shares for only a couple months, much shorter than my planned holding period of several years for most stocks. And there are a couple unusual reasons.

First, my personal portfolio reasons. I already have significant exposure to this stock through my holdings in Third Avenue Real Estate Value Fund -- this and three other Third Avenue funds are massive holders of Sears Holdings thanks to their big bet on KMart a while back. While they have been paring back holdings a little bit (which also is of some concern, but not a big deal because their holdings had become outsized portions of the portfolio with multiple hundreds of percentage gains), they still hold major portions of the stock. I think I might be better off letting Marty Whitman and his cohort manage this investment, because ...

Second, I don't have a great handle on profitability or plans for Sears moving forward. I bought this in a fit of star-gazing as I watched Eddie Lampert bring them back from the brink and make some masterful moves, including the Sears merger/takeover, but I think I bought too late to capture the magic of the turnaround artist ... and going forward, without the cost cutting and real estate story propping up the earnings and share price, I'm not sure Sears is going to grow fast enough to make it worth it for me to try to track them. A fine company, and I'm sure they'll continue to do well with good management, and I do generally love to buy stocks that don't issue guidance or supply information to analysts to make their jobs easy, but I also prefer to search out stocks that I can understand a little better and that I think have the potential for more dramatic growth. Plus, it's more fun that way, and as I've said before, if it's not fun, why not just buy an index fund instead?

And third, I want the money for some other investments that look more promising, and that are smaller companies (which is my general preference, all other things being equal). I may get a good price on Chico's tomorrow and if so I'll likely buy. I'm also looking at some other possibilities, including re-upping in some of my other holdings -- possibly Myriad Genetics (MYGN) or Protein Design Labs (PDLI) or Akamai (AKAM), all of which look very attractive to me at today's prices. I've also been looking into the companies that contract out to provide services and clinical trial management to the pharma and biotech sectors because I consider that sector to have significant growth potential with the expanding numbers of biotech drugs hitting the clinic, including Covance (CVD) and Parexel (PRXL), so if I get myself comfortable with those or other companies they'll be candidates as well. PRXL looks like it has the advantage of being much smaller and nimbler and a partial turnaround story, while CVD looks like the market leader with good sustained growth potential.

In all likelihood I'll be making a buy of some sort on Friday and will let you know what it is then.

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