“If you like the store, chances are you’ll love the stock.” Peter Lynch in Beating the Street (1993).
The biggest stock story of summer is the demise of Dick Smith Holdings (ASX:DSH). The high profile retailer listed on the ASX on 3 December 2013 at a valuation of $520 million only two years after private equity firm Anchorage bought the business from Woolworths for not much (the exact amount is disputed). Most analysis has focused on the role of private equity in taking the spoils from an audacious play. In this article, we draw on the advice of the legendary fund manager Peter Lynch to look for investing lessons from the Dick Smith debacle.
Who is Peter Lynch?
Peter Lynch managed the Fidelity Magellan Fund for 13 years until his retirement in 1990, increasing the value of $1,000 to $28,000 over this time. Time magazine called him the Number One money manager in the United States, and he cemented his reputation when his first book, One Up on Wall Street, became a worldwide bestseller and compulsory reading for all fund managers.
In his 1993 follow up, Beating the Street, he has a chapter called, ‘Shopping for stocks: the retail sector’ in which he says:
“Public companies on the way up, on the way down, on the way out, or turning themselves around can be investigated any day of the week by both amateur and professional stock shoppers. As an investment strategy, hanging out at the mall is far superior to taking a stockpicker’s advice on faith or combing the financial press for the latest tips.”
He then gives a detailed explanation of what he sees when he visits his local shopping mall, including kicking himself for missing out on Chili’s Restaurants which his three children loved. He says a lot can be learned in one location because what sells in one town is almost certain to sell in another.
“I don’t think of it as browsing. I think of it as fundamental analysis on an intriguing lineup of potential investments, arranged side by side for the convenience of stock shoppers. Here are more likely prospects than you could uncover in a month of investment conferences.”
My Dick Smith shopping experience
What happens when I apply the Peter Lynch shopping advice to Dick Smith? I’m a ‘typical’ consumer of electronic goods rather than a tech geek. I don’t need to be at the leading edge by buying every new gadget, but I like to keep up with technology. I have a basic understanding of what I want but often need technical assistance.
Going back a couple of years, I would regularly shop at Dick Smith for electronic needs, and even under the latter stages of the Woolworths ownership, I thought it was a good shopping experience. Young, enthusiastic techies knew their stuff, and were tolerant in explaining the obvious to an older generation. Prices were competitive and there was a willingness to price match.
One memorable incident sticks in my mind from a few years ago. The young salesman tried to upsell me into an extended warranty, but I knew these were usually expensive and not necessary.
I told him, “I would never find the receipt and warranty in a couple of years when I need them.”
“Don’t worry”, he said confidently. “We’ll keep your records here and all you have to do is bring the goods into the store and we will fix them.”
That was an impressive customer service.
In private equity hands, I felt their offer remained at least consistent and perhaps improved, especially on the marketing side. The yellow Dick Smith brochures came into our home every week, and along with JB Hi Fi, Harvey Norman, Bing Lee and online retailers, I would usually check Dick Smith’s prices. My impression as a consumer rather than a stock analyst was that Dick Smith and its private equity owners were building a solid business, but I made no attempt to analyse the company’s financials, nor did I participate in the float.
At the time of the ASX listing, Dick Smith passed the basic Peter Lynch test of being a good, busy place to shop with enthusiastic staff, smart products and competitive prices for the serious consumer. Based on Woolies’ experience, maybe this was never enough to make a decent return on capital and it was always doomed, but as a shopping experience, it looked on the money.
For the consumer, what went wrong?
Dick Smith was a listed company for only two years. In the post-float months, it retained the same external modus operandi as when in private hands. It increased store locations to an impressive 393, giving it scale and exposure.
But at some point, something changed. I have checked with friends who confirm my impressions. According to Lynch, I can make this judgement based on visiting just a couple of stores.
Notable was the less experienced staff, and a need to check with the manager to answer questions. There was significantly more Dick Smith-branded product, when electronics and communications are obviously brand markets. Nobody wants a Dick Smith laptop. And fewer of the bright yellow signs that enticed with specials.
But the real surprise came towards the end of 2015. I was shocked by the local store’s changes. Looking for a laptop, I had researched the market and knew what I wanted and the alternatives. Despite Dick Smith listing my chosen laptop online, the store range was pathetic. Old and inferior models, and no enticing price offers.
I asked a staff member if the laptop was in stock, and he did not know and checked his computer. This was a top seller which had sold out at a couple of Bing Lee stores, where their staff instantly knew the model. Then no attempt by Dick Smith staff to sell me something else. The store looked different. None of the eye-catching, large price posters you see in JB Hi Fi or Harvey Norman, but just shelves of tired-looking stuff. They had moved the checkout from a pod structure in the middle (where you were forced to pass heaps of other products) to a desk next to the exit door. The place looked like one of those standalone stores where no overall corporate marketing theme and look had been applied.
Many people in the media have criticised Dick Smith’s bankers for calling in administrators, but based on my experience, they had to. The problems were endemic, not a matter of a poor retail cycle. Harvey Norman and JB Hi Fi have been trading well, and household goods sales were up over 8% in the year to November 2015. Retailing is fast-moving where the quality traders respond to customer trends and manage their inventory, and applying the Peter Lynch test, Dick Smith lost its way.
Two months before going into administration, on the day of its 2015 Annual General Meeting, Dick Smith issued this market update:
“Gross profit was adversely affected by increased promotional activity and unfavourable product mix, with strong sales growth in unlocked phones and fitness and disappointing sales in tablets, gaming and accessories. Channel mix was also negative, with strong online sales growth offsetting softer retail store sales, impacting gross margin.”
Limitations of the Peter Lynch method … or me
Although there is great intuitive appeal in the Lynch method, I’ve often struggled with it. Maybe this says more about me than the company. I don’t like the way Harvey Norman stores are split into separate franchises, so one person cannot help on another’s product range. I hate loud music playing when I buy jeans, and I don’t get a thrill watching an app showing where the Domino’s Pizza delivery bike is located on its way to my house. I’d rather pay for an Italian gelato than a cheaper ice cream at Wendy’s. I like shopping at Myer and David Jones but they have both struggled.
On the other hand, the appeal of Bunnings is obvious, and Lynch would love the Sunday morning queues (and the direct exposure possible through the Bunnings Warehouse Property Trust and the less directly via Wesfarmers) if not the terrible sausage sandwiches.
And I like roasted almonds in my homemade muesli, and in recent years, I’ve noticed the incredible increases in price due to the Californian drought, and they’re still selling in my area for $13.99 for 500g. Yet Select Harvests’ share price has halved to around $6 from a high of $13.48 in April 2015, mainly due to rain on the US West Coast, where most of the world’s almonds are grown. I’m still waiting for cheaper almonds in my retail store.
Which shows that while ogling in a shopping centre can be part of the stock purchase decision, there are many other factors to check. So we’ll finish with a couple of other Peter Lynch quotes:
“Behind every stock is a company. Find out what it’s doing.”
“The person that turns over the most rocks wins the game.”
The analysts who were still recommending Dick Smith in late 2015 were too busy looking at numbers and not standing in a Dick Smith store, channeling Peter Lynch.
Graham Hand is Editor of Cuffelinks and has almost 40 years of experience in various segments of the finance industry. He has never worked in retailing.