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Lecture #5: An Investor Specializing in the Retail Sector discusses ARO, AEOS, ANF
 
John Chew at aldridge56@aol.comstudying/teaching/practicing investing Page 1
 Editor: Go to the Appendix on page 12 and study the 10-Ks of ANF, AEOS and ARO to determine whether these are good businessesand what they are worth BEFORE reading this lecture. The lecture illustrates the power of a focused/specialized approach.
Class # 5A Professional Investor specializing in retail store investments: ARO, AEOS, ANF
November 08, 2005Hopefully you will read the
 Magic Formula
book for next Class
 Another Great Investor’s (“ 
 AGI 
” 
 )
Presentation on investing in retail stocks.
GI = the professor and great investor.
(―GI‖):
Before she speaks, just to give you a context, she sticks to one area:
consumer productsand retail.
She has been in that area for 10 years and has averaged high 20s percent returnsstaying in that little
niche
that she knows well. She finds enough opportunities in that one area.Her returns have been no more volatile than other concentrated investors. She has phenomenal
returns focusing on what she knows. There is a great lesson for you. It doesn’t have to be retail
but an industry that you understand. She picked something she really enjoys--that is a veryimportant lesson.A number of people have come up to me before class and said they will join a big firm and theyare afraid they will be pigeon-holed. That may be true, but you can really learn an area very welland still be very profitable. As you invest over a long period of time you will come to know moreareas. Knowing one area well is tremendous. This investor shows how well you can do in afocused investment area and with a well-honed circle of competence.
She will talk about areas she is working on…….
What is a girl from the suburbs doing in retail?
(―AGI‖):
So what is a girl from Long Island doing in retail? Pick an area that you can know andthat you can understand well and that you enjoy.
I like shopping.
It is definitely an area I have tocome to know well. You start to see patterns. Over a ten-year period you learn how a particularindustry group trades that gives you a big advantage over people who are first looking at the stockand coming in cold and not having the background.I like retail because you are constantly getting information
(the barrage of same store salesreports causes more volatility)
. You get it on a monthly basis and sometimes on a weekly basis.Retailers put out same store sales numbers-Comparable sales in stores for a year-over-yearperiod. Monthly basis but most industry groups you normally get quarterly numbers. The moreinformation you have, the more people try to trade on the information before, after and during.You get a tremendous volatility
in this sector. A lot of people don’t like vola
tility. As far as I amconcerned, I can live with volatility if there is a good opportunity over the long term. And if I amtaking a two years
’
time horizon that is actually my greatest opportunity--are these monthlynumbers.Inevitably these companies are going to miss because of their fault or no fault of their own due tothe macro environment. There will be a missed number and the market tends to have no mercy.So the market kills these stocks. One day it is trading at 20 times and the next day it is trading 10
 
Lecture #5: An Investor Specializing in the Retail Sector discusses ARO, AEOS, ANF
 
John Chew at aldridge56@aol.comstudying/teaching/practicing investing Page 2
times
(earnings)
but nothing has fundamentally has changed. That fundamentally is youropportunity. So you must live with a little bit the anxiety. Believe me when these stocks aredown 30% to 40% it is hard to pull the trigger, but that is usually the best time to buy.
Volatilityis your friend.
I don’t know how to pick the next trend. I really don’t know fashion. I say this: nobody can
predict fashion. It is really is not about hitting the next trend on a continuous basis.
Are thesecompanies running a good business over the long-term?
Are they running a business that canweather the ups and downs?The best time to get in is when they (the retailer
’
s management) missed a season of merchandisebecause if you look at the fundamentals of the company and it is well-run and the stock getscrushed because they miss a season of merchandise, then it is an opportunity to own for the longterm. It is really irrelevant if they pick the hot trends or not.It is very interesting because the Street misses the point on retail. Most analyst reports focus onhow this company will do in Oct? How will this company be affected by Katrina (hurricane thatdestroyed New Orleans) or higher heating prices for Christmas? These are all relevant questions,but not relevant if this is a good business. Fundamentally it will be around? If you buy it at the
right price it really doesn’t matter what is happening to the customer today because they will be
around and they will continue to buy.A quote from
Fortune
last year from a Hedge Fund manager who
often invests in retail, ―I have
my people visit stores to see how much the items are marked down or if there are long lines at theregister and I buy if this company will beat numbers and short it if it misses numbers. It is thatsimple.
He really misses the point.
It is not that simple. If I had to invest that way, I would lose sleepover whether I could consistently do that. Maybe I would get it right only 50% of the time. Iwould have a lot of anxiety in between. If you can take a longer time horizon for one to twoyears, you will have an edge.
You have to buy these things when people hate it
because that,obviously, is when your opportunities are available. So you have to be a contrarian.Can you see my slide: This is a price chart of 
 AEOS, American Outfitters
.
 
Lecture #5: An Investor Specializing in the Retail Sector discusses ARO, AEOS, ANF
 
John Chew at aldridge56@aol.comstudying/teaching/practicing investing Page 3
Here is the two year price chart, it was up then down. So the first thing you notice
there is a lotof money to make in this stock.
Two years ago it traded at $7.5. Here at $10, they had $3 to $4dollars of cash on the balance sheet, you knew they were not going under. Strong balance sheetsare critical when investing in retail due to the cyclicality of their business. Yes, they missedsales
 — 
is anybody familiar with this story?Basically they were off-trend for a while. They were not sure how to position themselves in themarketplace. They tried to compete against (
 Abercrombie, ANF 
but th
ey didn’t have the cache.
Back in 2004 they were not addressing their customer
 — 
the fickle teenager. Back in 2003/2004they were missing the boat with their customer; they were not meeting their needs.Fast forward six months, they got their inventory under control and they turned their merchandisearound. Comparable store sales turned around, that was the
key. Back in 2004 it wasn’t that their 
earnings potential was any less than six months later, it was the fact that comps
(comparablesame store sales)
were
negative. This company doesn’t deserve this multiple because they are
showing negative comps so it should trade at six times potential earnings net of cash. To me thisis a company that will be around. They have a healthy balance sheet. Yes, they have merchandisemisses; yes their same stores sales are down. But they are making changes to their managementteam; they are on top of their inventories. They got hit on inventories in 2004. Certainly there ispotential there.As soon as people as people saw comps stabilizing and they recognize that they could get back tomore normalized earnings and margins, the stock basically tripled. This is one example how youcan make money in retail if you get in at the right time.Next Chart:
 ANF 
:Does anyone know the story here? Basically the same thing happened. Comps were negative forawhile; there were merchandise misses, they tweaked their management team. Back in their2003/2004 area, despite the fact that they had a strong balance sheet and strong customer base,
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