Postmortem: Denny's

Entry Price: $5.99

Exit Price: $3.70

Return: -38.2%

Alpha Contribution: -3.64pp

Hold Period: 197 Days

Denny's has been far and away the worst decision I've made over the course of my first year investing. There's a number of lessons I feel I've learned from this position and I'm grateful I had a blowup early in my career in an idea that I had high weight in.

Margin of Safety

The most salient lesson that sticks out to me when reflecting on the Denny's thesis concerns margin of safety. I'm a big believer in Howard Marks' sentiment that there's no such thing as a bad asset, just a bad price. However, at a mid-teens multiple I was not being compensated enough for buying a mediocre business that's actively getting worse. I had no business paying that multiple for Denny's when I can pay the same for a company like Deckers. A mentor of mine at Grandeur has told me that some of the worst mistakes he's made in his career arse buying into meddling businesses that are getting incrementally worse but look cheap. That's certainly what I did here.

This is part of a bigger lesson I've been learning over the course of this summer. I tend to like a lot of ideas but the bar for what I should and shouldn't buy needs to remain very high. I want to own companies in which I have a strong thesis with a lot of conviction. In my initiation report I listed my conviction as a 6/10. In retrospect that was clearly to low and indicative that I wouldn't have the confidence to hold this idea unless things were correct quickly.

Living in the Model

A mistake I made last fall and this winter was that I believed there was a direct correlation between the quality of my thesis and the quality of my model. I would spend all my time making sure the Balance Sheet was balancing in the out years and not enough time on the qualitative analysis, reading earnings calls, and understanding the business model. I still don't totally understand the intricacies of the franchise model and this means I didn't know what I owned.

I need to use models as a question asking tool and to help me understand the economics of a business. Just because I can model a return or build a DCF that indicates there's alpha to grab doesn't mean I've got a good thesis. I want my models to be a tool where I can put my assumptions, which have been studied and tested, to see if the market coming around to my beliefs can help me generate a return. There can be no more modeling without truly understanding, otherwise my models become vices of false confidence.

What I did Well

While living in the model was a mistake of mine, I am proud of how hard I worked at it. It was a really good revenue build for me at the time. I also like that I am naturally good at thinking differently from the market. At times I can be a kneejerk contrarian, but I'd rather be that and have to force myself to understand the markets position than being a kneejerk follower. I need to remain cautious with my contrarianism, though. Oftentimes there are very valid reasons for large sell offs in a stock and if I want to try catching a falling knife I need to be very sure that the quality of the company and it's management team warrants taking that risk.

Conclusion

Both my Otter Tail and Denny's pitch have similar themes that I don't think I want to have showing up in my owned names anymore. The theses of both these pitches was something like "things have gotten worse, or will get worse, but not as bad as the market is thinking". That's a tough game. This reminds me of the realization that led to the switch Buffett made in the middle of his career when he realized it was much easier to buy good businesses and compound value then find cigarette butts and get that last puff. I still love the idea of investing in fallen angels and my two biggest weights in the portfolio fit that profile. I just need to make sure they really are fallen angels and not fallen dogs.

I'm very grateful for the learning experience Denny's has been and am looking forward to doing some case competitions this year to rectify the mistake this has been. It'll be very interesting to see if this management team can turn this around in the face of all the bankruptcies and failures in the family dining scene over the last year. I'll definitely continue to check up on this name and am excited to see if there was any validity to my thesis in the long term.