118 - NACCO Stock Post-Mortem $NC

Mental Models discussed in this podcast: Durability Post-Mortem Resulting Capital Allocation Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Support the Podcast on Patreon This is a podcast supported by listeners like you. If you’d like to support this podcast and help me to continue creating great investing content, please consider becoming a Patron at DIYInvesting.org/Patron. Show Outline The full show notes for this episode are available at https://www.diyinvesting.org/Episode118 Timeline NACCO spun off Hamilton Beach Brands in September 2017 I first bought shares in March 2018 at a price of $40 per share I averaged down in May and June 2018 with shares at a price of $34 per share. Averaged down in September 2018 at $32 per share and October 2018 at $29 per share Within a year, the stock doubled to over $65 per share in October 2019. This is the recent peak. Instead of selling, I held because I valued the company at $75 per share at the time. It wasn't yet at fair value. May and June 2020, I averaged down again at $26 per share and then $22-24 per share. In March 2021, I recognized that holding $NC was a large opportunity cost on my portfolio and I shifted some money to other stocks while the stock was around $24-25 per share. In May 2021, I exited my stake in $NC completely at a loss around $25-26 per share. Some lots were sold at a gain and some at a loss. Overall, the position was a net loss and a much bigger loss on an opportunity cost basis. Thoughts and Key Questions I should have sold or trimmed after the stock doubled in less than a year. $65 per share was within my error margin for my $75 fair value estimate. Even simply reducing my stake by half would have been a good decision. The main reason I didn't do this was that it would have had to sit in cash. I didn't have many other good ideas at the time. My biggest mistakes are often made when I'm in cash or when I would be creating a cash position. (Always do research for new ideas!!!) Was buying $NC in the first place a mistake? No, I don't think so. My theory was sound. I expected positive news from NACCO and it was cheap at $40 per share. It was the best idea I had at the time, I was also running a diversified 10-15 stock portfolio when I bought NACCO.  My thesis was correct, but I had thesis creep as news flow came out. My original valuation placed the stock as worth between $50-65 dollars. I only upped my estimate after high natural gas income. I should have recognized that was temporary and sold.  I thought NACCO was a 3-5 year hold business, but it probably should have been sized as a last puff cigar butt. When that puff came within a year, I should have sold.  Did I accurately assess NACCO's business model quality? Yes. NACCO's service model of earning money from unconsolidated subsidiaries allows it to earn high returns on capital as the customer puts up all of the capital. Did I accurately assess the durability of NACCO's business? No. I misestimated the likelihood of a coal mine closure. I did assess that coal mine closures were likely and I accurately predicted the degree to which they would harm the business. However, I underestimated the degree to which NACCO's stock would decline. I thought the decline was overdone.  Did I accurately assess management/capital allocation? Partial yes, Partial No. I accurately predicted that management would NOT dedicate new capital to new coal mines. I accurately predicted that free cash flow would be dedicated to growing the North American Mining business. However, I underestimated the maintenance CapEx needed for the MLMC consolidated coal mine. This sucked up a large amount of cash flow for the 3 years I owned the stock. Future maintenance CapEx is going to be lower, but the timing was bad on my part.  I also underestimated the ROIC from the money put into the North American Mining business. I expected higher returns for the cash outlay. Thoughts and Lessons Learned Don't buy companies that lack durability and really dive into this question of durability.  A mistake on durability could mean that a very low P/E is justified.  Personal preference: I highly prefer buying steady growth companies. I did not enjoy the constant negative and bad news reports from the company while I owned it. The primary problem with owning NACCO for the last 3 years was the opportunity cost of how that money could have grown with other better companies. My actual losses weren't that high. Some of my purchases made a profit. However, the process of turning one profit center (COAL) into a new profit center (NAM) is slow and costly. That's basically a turnaround situation. I don't want to own turnaround situations until after they've been turned around. It's basically dead money Creates large opportunity cost situations Management is critical I want a management team that I believe is fully aligned with me on skin-in-the-game. NACCO has a good management team, but they don't run the company how I would run the company. They receive regular ongoing stock options and issuance which dilutes me as a shareholder. There isn't a lot of insider buying and there weren't a lot of share buybacks which I would have preferred. If I were assessing NACCO today, while I still believe it is cheap, I don't think it would pass my current management/capital allocation filter. Perhaps that will change in the next 5-10 years.  Be wary of thesis creep. NACCO would have been one of my best success stories if I simply sold it after it hit $60 per share. A quick double and it would have been a lot of money for my portfolio as a 20% position.  Instead, I allowed my thesis to creep which resulted in $NC being a drag on my performance for years 2 and 3 of my holding period.  Summary: I want to buy and hold high-quality, durable businesses that are growing AND are selling at a cheap price. NACCO had a cheap price and was high-quality, but it was of low durability and had no growth. Going forward, I am going to be more diligent at filtering out ideas that don't meet ALL of my highly stringent criteria.