Can an investor make great returns from a company that continues to lose money? Absolutely. This may sound counterintuitive; it seems strange that a business owner can make money on a business that loses money, but in the end it all comes down to the price that is paid for that business. When the margin of safety is so large that the company can lose money for years and still not erode the investor's principal, big profits can come from even companies that are experiencing losses.
Consider Sport-Haley (SPOR), marketer and distributor of fashion golf apparel. When we last discussed this company, it was losing a few hundred thousand dollars per quarter. Fast forward to today and it is still losing money, having lost almost $500,000 in the quarter ended March 31st, 2010. And yet, its stock price has almost doubled over this time frame!
Is this stock return just a lucky outcome? After all, how often can a company's earnings and its stock price appreciation have so little in common? My contention is that while there are some elements of luck involved (e.g. the investor cannot determine whether the stock price will be up a certain amount in such a short period), the investor puts the odds firmly in his favour when he considers an investment's margin of safety first and foremost when making an investment decision.
In the case of Sport-Haley, three months ago the company traded at a massive 80% discount to its net current assets! This means the company could continue to lose money for several years, and the investment principal would still be protected. It also means the potential for stock price appreciation is rather high. After the recent stock price run-up, the stock still trades at around a 60% discount to its net current assets.
Of course, no investment return or time frame is guaranteed. But when the investor buys at the right price (i.e. utilizes a large margin of safety), the odds of generating market beating returns are on his side.
Courtesy Baral Karsan
