I had owned the stock for years. I liked the business, I liked the assets and in particular, I really liked the CEO. He was a hard worker and he had the bags under his eyes to prove it. He lived and breathed his job. I remember seeing him at an industry party with the same bottle of warm beer for hours. He wasn’t there to socialize and enjoy life—he was there to learn about the competition and to build his rolodex. He was my type of CEO. Over the years, I became quite friendly with him—it’s what happens when you call once a month to ‘check in.’ I literally intended to own the shares forever. I was just that confident in him.
Unfortunately, other investors eventually realized the same thing. The shares went to an absurd price. I wanted to hold on because I really liked the guy—but at some point, you ask yourself—what is the upside from here? The shares were already up ten-fold. I sold a few shares and my favorite CEO sold some as well. The shares continued higher and I sold the rest of mine. We both realized that the share price had significantly overshot what the valuation of the business was. We both made millions.
Over the next two years, we still chatted—less frequently, and I still followed how the business performed—though I followed it less closely. Even though the business continued to grow, the shares began to slowly decline. I was right—it had been overvalued. The shares dropped 70% from where I sold, and I began to become more interested in the business again. I even bought a few shares, as they pulled back. At the same time, I was also concerned about some of the fundamentals of the business. The growth had trailed off and the margins were in freefall. They had also lost a few important contracts. In the end, small cap investing is all about betting on the CEO—none of this mattered to me, because he was one of my favorite CEOs. However, these factors did give me pause about jumping back in. I bought slowly as the shares continued to decline. I was hoping for a larger drop so I could become aggressive. Then, I met him at an industry conference.
I was talking to a friend when a hand grabs my shoulder. I turned around to see my favorite CEO, whom I hadn’t seen in person in two years. He was fall down drunk and they hadn’t even started dinner. He had also gained thirty pounds—and this was a guy who ran marathons for fun. He leans on my shoulder and asks, “do you want to do something fun after this?” He had the same mischievous smile that I remember my fraternity brothers having before someone got arrested. Before I could even get a few words in, he stumbled off to see someone else. This wasn’t the same guy I remembered.
Now, I cannot fault a guy for being drunk at a party—heck, I was also there to enjoy myself. However, I didn’t show up drunk, and I was there to do my job—keep tabs on an industry that had a lot of potential. You cannot fault a guy for gaining weight or for wanting to live a little. I cannot tell you what it was, but something told me that he wasn’t the same guy I had admired so much a few years back. He had changed.
On the flight home, it all started making sense. The declining margins, the slowing growth, the loss of key contracts—he just wasn’t focused on the business like he used to be. He had cashed out and was living the good life with all the money he made. The guy ruled with an iron fist, there was no one under him to take charge. The business was falling apart and would have collapsed if he hadn’t built it so well on the way up. When we landed, I sold the whole position. I took a small loss and watched as the shares dropped another 70 percent from where I sold.
I don’t know how to explain it. Sometimes, you just know something isn’t right—even if it isn’t obvious. At the time, the shares were getting cheap and the business still appeared well run. A year later that things really came unglued. Sometimes, you need to just trust your intuition. It’s there for a reason.