Monday, December 22, 2014

Why you should be careful when "Investing in What You Know"

Hello everyone!

I was inspired to write this post some time ago as I was sitting down doing work at one of my absolute favorite places in the world-- Barnes & Noble. Or, should I say-- the Starbucks cafe inside Barnes and Nobles locations. I don't know if I have said this before but for some reason when I need to get away either to focus on work or to simply relax and let go of any kind of stress that may be going on in my life, Barnes and Noble is a go-to place for me. Apparently many other individuals share my obsession as these cafes are usually packed with people all the time either diligently studying, doing work, or simply reading and relaxing. Whenever I am away in another state for long periods of time I make it my mission to find a nearby location and it always feels like home again.

The Starbucks (sbux)-Barnes & Noble (bks) partnership is one of the best strategic business ideas ever. Did you know--- this partnership was established back in 1993 and is an idea that has benefited both retailers greatly over the years. Initially, Barnes and Noble paid Starbucks a licensing fee to be able to serve Starbucks coffee at their locations. Today, it appears that Starbucks also pays Barnes and Noble for the full presence of their cafes. I tried to find the exact details on how this partnership works exactly but couldn't find any final answers. If you know it, please share.

Now, if I were to follow the infamous Peter Lynch philosophy of "investing in what I know", perhaps I would pull the trigger in buying some shares of Barnes and Noble simply because I am a loyal customer and I rave about it all the time. However, as investors, we must make sure to complete that "background check" in each and every company where we are thinking of putting our hard earned money to ensure a nice return on investment. 

Some companies need a lot more research than others. For this particular situation, it is my opinion that not much research is needed to understand that B&N may not be the best place to put my money during these rapidly changing times. Some reasons include but are not limited to:

1. Brick and Mortar locations have been suffering greatly for quite some time mainly due to the fact that eBooks and eRetailers have taken this industry by storm. We've all heard about the bankruptcy of incredible companies like Borders. Thankfully, B&N has been able to survive as the only major book retailer company with physical stores but who knows how long they will be able to sustain this.

2. The company has been aggressively trying to stay afloat by closing under performing stores, developing/adjusting/ultimately dropping their own tech-reading devices (the nook), as well as revamping their online presence. It seems that they continue to work hard in making strategic moves that can help them stay relevant. Despite all of these attempts, there is a massive amount of competition out there and many wonder whether B&N will be able to keep up. 

3. The company has a strong competitive advantage in the fact that is probably the only place available where one can go and buy an immediate book in "real time" rather than having to wait for something ordered online. Some of us just want our stuff now rather than later. However, I would argue that companies like Amazon coming up with their new "amazon locker" or even the futuristic drones system can be a threat to this advantage in the long term.

Although financials for Barnes and Noble have been less than stellar they have not been insignificant by any means. The company  did manage to produce free cash flow of about $185 million during this past fiscal year (obviously a significant amount). However, going over their most recent earnings report (for second quarter fiscal 2015) it is apparent that the company continues to suffer in consolidated retails sales (sales in physical stores as well as B& which they announced will continue to decline for the next consecutive quarters. Although their college segment looked promising, they announced possible declines in this area as well. You can read the entire earnings release here.

Note: Although I may not necessarily buy shares of the company, I am still a very loyal customer for well over a decade and will continue to be for as long as possible. It is my hope that they are able to maintain their brick and mortar presence for many years to come. 

This may seem like a 'simple' example but next time you are absolutely in love with a company or a service make an effort to take your emotions out of the equation and do a serious analysis of that prospective company you are looking to invest in. You may find that although is a favorite of yours the reality and potential for profitability may be very different than what your "emotions" or "personal opinion" is. 

As always, make sure to: company news, read several quarterly and annual reports (current and going back a couple of years if possible), check out the financials and top line (net income) over time, profits, current debt, strategic plans for the future, how they plan to thrive over competition. Look closely at the industry in itself and think about whether this is a sustainable industry or one that may one day be taken over by technology or the infamous "internet of things". 

Do your homework and make educated investment decisions. Stock market investing should never be a "gamble" or based on emotions. Decisions should be made strategically and with a solid amount of analysis backing us up. As I have mentioned before, is an excellent idea to keep a journal of why you made a purchase and if that thesis ever changes, maybe is time to think about changing your strategy. 

Question: Which companies/services do you absolutely LOVE but wouldn't necessarily invest in? Would love to hear your thoughts.

As of the publication of this post the company trades at $23 per share and pays no dividends. I have no positions on $BKS. I do own shares of $SBUX.