Why I sold Stephan Company

Nate has written a good post about Stephan Company (SPCO) on his website.

People who follow my Twitter account will know that I also owned some SPCO shares, but that I recently sold my shares after I read the latest annual report and the quarterly report for March 31, 2013. Revenue continues to fall and the company is now posting losses and burning cash. This is a very different situation from when I first bought my shares, which was even before Ferola died, I believe. At that time Stephan Co. was a profitable net-net and it was generating cash.

Like Nate, I also thought that the death of Frank Ferola could unlock value for shareholders. It did act as a catalyst in a way – a catalyst for problems – because a number of them surfaced after new management took over. A good example is the revaluation of the inventory. In the 2011 annual report the balance sheet showed $3.4 million in non-current “Other assets”. In the notes I read this was non-current inventory. These were slow moving items, but they were not deemed obsolete at that moment in time. After Ferola died and new management took over they rationalized Stephan’s product line and disposed of $5.7 million of inventory, incurring costs of $260k to get rid of it.

In hindsight the non-current inventory was a red flag and something I should have paid more attention to.

There was one other thing that I noticed and it might sound a little silly. As Nate mentions in his post, the company had a severely outdated website. Their subsidiaries did as well. What caught my eye at the time when I first looked at their website was that the title of their homepage misspelled the company name. I think it said “Spephan Co.”. It might sound like a minor detail, but this is the text that is shown in the title bar of your browser when you visit the site and the <title> tag is also indexed by Google and an important factor for ranking well in their search results. This typo was on the website for a very long time, well over a year I think. When new management took over, the website was completely revamped.

On company websites

How can a simple detail like that not get corrected? Surely you would notice it when you visit your own site. Surely management received some other complaints about their outdated websites. After looking at hundreds of micro-cap company websites I think I can often tell if company management pays attention to detail.

Positive things to look for in a company website:

  • The website shows the latest products and services
  • Discusses important industry news and developments
  • Shows a bio of the managers (bonus points for profile pictures, personal e-mail contact info, a family history: the less anonymous managers make themselves the better it is)
  • Detailed IR info: not just links to the latest filings on Edgar or OTC Markets, but PDF’s of annual reports, recent stock ownership information, etc.
  • Historical press releases
  • A detailed history of the company
  • Conference call transcripts. I also saw some companies in Singapore that allow investors to ask questions via chat / e-mail once in a while and the companies then publish the Q&A on the website.
  • A website that is information rich, but not promotional. Is the company willing to share negative news and industry developments?

In general: the more the company is willing to share that is beyond the minimum required, the better. I think the motivation of management is often reflected in the company website. A passionate manager of a family controlled business is proud of the company and its history. This attitude goes beyond just having “skin in the game” and is more about behaving in a way that would have the approval of earlier generations of the family if they were alive today. Nassim Taleb used the term “soul in the game” somewhere in his book Antifragile and it reminded me of the attitude I sense in some family controlled businesses.

Even if the company does not get any revenue from e-commerce, their website is still important to them. They pay attention to detail and want people to get the right impression of the company.

A fancy website is often not a good website: a lot of speculative companies (biotechs on the pink sheets come to mind) use impressive looking flash movies, but there is very little detailed information on those websites, they are purely built to sell the (often worthless) stock to investors.

The old Stephan Company website communicated an entirely different message from the one I like to see. If I had to describe it in one word, I would choose “neglect”.

Why I sold

After I read the most recent reports, I realized the company is probably not going to get sold before management has turned around the business. I have no idea if and when they will succeed. There was a bid of $1.50 for the shares and since this was above current NCAV it seemed the right decision for me to sell. I was surprised the share price had not dropped more at that point, perhaps the delayed posting of the latest reports had something to do with it.

My initial reasons for investing have all disappeared. I think Stephan Co. is now mainly a turnaround situation and I don’t think I can judge what the chances are that management will succeed. I took a loss of about 40%. Fortunately it was a small position for me, but it is much better and cheaper to learn the lesson from someone else than to pay for it yourself.

On hindsight bias

It is hard to judge whether you could have prevented a bad investment. I tried to describe a few things in this post that now seem like red flags, but hindsight bias is always present in our minds and makes things seem very obvious after the fact.

I once invested in Lakeland Industries (LAKE), I think it was a net-net at the time. The company posted decent results and when another company named Ansell announced a position of 10%, the stock went up and I eventually sold. Some time later, the company lost an arbitration case in Brazil, had to pay a huge fee and this caused them to break some of their loan covenants. The pending arbitration case was disclosed to investors, but I had no idea all this was hanging over Lakeland’s head. The risk was always there, but I was completely blind to it. I don’t like my buy now when I review what happened later. But because I sold LAKE at a profit, my mind will tend to view this situation positively even though it was probably a mistake that might have been just as big as my mistake in buying SPCO.

Disclosure: no position in SPCO

Posted in Pink Sheet stocks, US stocks and tagged .

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