Learning From The Past, Part 3

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<< Read Learning From The Past, Part 1

I wish I could tell you that it was easy for me to stop making macroeconomic forecasts, once I set out to become a value investor. It’s difficult to get rid of convictions, especially if they are simple ones, such as which way will interest rates go?

In the early-to-mid ’90s, many were convinced that interest rates had no way to go but up. A few mortgage REITs designed themselves around that idea. Fortunately, I arrived at the party late, after their investments that implicitly required interest rates to rise soon, fell dramatically in price.  I bought a basket of them for less than book value, excluding the value of taxes that could be sheltered in a reverse merger.

Photo Credit: Thibaut Chéron Photographies

Photo Credit: Thibaut Chéron Photographies

For some time, the stocks continued to fall, though not rapidly. I became familiar with what it was like to go through coercive rights offerings from cash-hungry companies in trouble.  Bankruptcy was not impossible…and I burned a lot of mental bandwidth on these. The rights offerings weren’t really good things in themselves, but they led me to buy in at a good time. Fortunately I had slack capital to deploy. That may have taught me the wrong lesson on averaging down, as we will see later. As it was, I ended up making money on these, though less than the market, and with a lot of Sturm und Drang.

That leads me to my main topic of the era: Caldor. Caldor was a discount retailer that was active in the Northeast, but nationally was a poor third to Walmart and KMart.  It came up with the bright idea of expanding the number of stores it had in the mid-90s without raising capital. It even turned down an opportunity to float junk bonds. I remember noting that the leverage seemed high.

What I didn’t recognize that the cost of avoiding issuing equity or longer-term debt was greater reliance on short-term debt from factors — short-term lenders that had a priority claim on inventory. It would eventually prove to be a fatal error, and one that an asset-liability manager should have known well — never finance a long term asset with short-term debt. It seems like a cost savings, but it raises the likelihood of insolvency significantly.

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Disclaimer: David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent ...

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