STORE Capital Stock: Farewell and our checklist manifesto

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Thesis

In a book titled “The Checklist Manifesto – How to Get Things Right?”, author Atul Gawande made a compelling and insightful argument for the need for checklists, especially in professions where checklists are particularly bad. views. on. The author, being a general surgeon (and also a professor at Harvard Medical School), analyzed the underlying reasons. People in professions such as investing and surgery, who are usually very smart and highly skilled, tend to believe that their success depends not on silly checklists, but on improvisation and intuition – even against more and more evidence.

Being disciplined investors ourselves, we have developed our own checklist over the years. This checklist helped us avoid major mistakes and identify successful opportunities such as today’s main topic: STORE Capital (NYSE: STOR).

STOR appeared on our radar in August 2021 and we started covering it. We have turned bullish since the start of 2022 as valuation compresses as seen in the chart below. In our view, the market has exaggerated the perceived effects of interest rate hikes. We recommended “buy” when prices dropped below $30. STOR recently announced a definitive agreement to be acquired by Oak Street at $32.25 per share in an all-cash transaction. The acquisition price represented a premium of approximately 20% over its closing price on September 14, 2022 (the day before the announcement of the agreement). Combined with its dividend yield, which has averaged about 5% over the past few years, shareholders who have bought less than $30 are handsomely rewarded, especially considering the fact that the overall market has suffered a correction to double digits over the same period.

Given the ongoing acquisition, this article is most likely our last STOR article. And as such, I want to take this opportunity to say goodbye and wish the company all the best in the new Oak Street family. At the same time, I wanted to share a few items from my checklist that helped us identify it in the first place. And hopefully this simple checklist will also help other investors with other investment opportunities. These simple checkboxes are listed below, and the rest of the article will detail them one by one:

  • Don’t bet against Buffett.
  • Always interpret valuation in the context of risk-free interest rates.
  • Don’t confuse diversification with diworsification.

History of STOR stock ratings

Source: Alpha Data Research

Don’t bet against Buffett

If you are reading this, you should know that Warren Buffett has built up a large position in STOR since the second quarter of 2017. As you can see from the chart below, he started buying in the second quarter of 2017 and gradually increased his position at 24.4 million shares in Q3 2020. At its peak, the market value of this STOR position was over $0.8 billion (somewhere around the second half of 2021). Sure, it’s not the largest position in his mammoth portfolio, but 24.4 million shares translated to about 10% of total STOR shares outstanding – a strong endorsement of STOR in my opinion.

Our experiences have taught us not to bet against Buffett. Additionally, our experiences have also taught us that if we can buy stocks at prices below the “Buffett price”, our odds improve significantly, as detailed below.

STORE Ownership/business history

Source: DataROMA, Warren Buffett STOR fund

Buffett’s price and the role of risk-free interest rates

My previous post from February 2022 detailed the “Buffett price” or more specifically, the Buffett valuation at which he accumulates most of his stock. As detailed in this article:

Buffett bought his shares near 13.2x FFO in 2017 and 2020 respectively at prices near $22 to $23, as you can see in the following chart. The stock price climbed to nearly $37 at the end of 2021. And the recent price correction has taken the valuation to around 15.2x FW FFO at the start of February 2022, which is still around 15% above the valuation that Buffett paid for his actions.

STORE Capital and FFO per share

Source: Author based on data from Seeking Alpha

However, we must remember that valuation must always be interpreted in the context of risk-free interest rates.

We have to understand that interest rates in 2022 are dramatically different from those in 2017 when Buffett started buying the stock. Since interest rates act as gravity on the valuation of all assets, FFO multiples can be misleading and need to be adjusted for changes in interest rates. In terms of FFO multiples, the stock was above Buffett’s valuation by about 15%, but his valuation was actually more than surface level when his yield is adjusted for risk-free rates. Its valuation was then much closer to the “Buffett price” as shown in the graph below. As detailed in the same article:

The chart below shows the yield spread between STOR and the 10-year Treasury note. As can be seen, the spread is limited and treatable. The spread has been between about 1.25% and 3.0% most of the time, which makes sense for a stable and mature company like STOR. Which suggests that when the spread is near or above 3%, STOR is significantly undervalued relative to 10-year treasuries (i.e. I would sell treasuries and buy STOR) .

Now the pink squares indicate when Buffett bought most of his stock. As can be seen, he started buying stocks in 2017 precisely when the yield spread approached 3%. And he added another 31% to his position in the first half of 2020 when the yield spread jumped to a ridiculous 5% due to a combination of very cheap valuation and near risk-free rates. zero. And you can also see that we got bullish on the stock when the yield spread started approaching 3% in early 2020.

By contrast, the yield spread has narrowed to only ~1.1% at the time of this writing (about 5.2% TTM dividend yield minus 4.1% 10 years), near the thinnest level since its IPO. At its acquisition price of $32.25 per share, the yield spread would be even narrower. So I would say that STOR shareholders got a very good deal with Oat Street.

STOR Stock 10-Year T-Bill Yield Spread

Source: Author based on data from Seeking Alpha

Don’t confuse diversification with diworsification

Finally, do not confuse diversification with diworsification. Owning more stocks can help you feel more diversified and therefore more secure. However, experiences have taught us otherwise. Holding a few well-understood titles is far superior to holding a large number of misunderstood titles, both in terms of security and performance.

And nothing illustrates this point better than the following comparison between STOR and the broader REIT industry (represented by VNQ). Details are provided in a previous article we published in April 2022. And some highlights are quoted here:

  • STOR offers greater profitability, consistency and valuation than VNQ. Its price to cash flow ratio is 30% lower than the industry average.
  • In particular, if we use dividends as a proxy for returns to owners, STOR currently provides a yield of around 2.4% above VNQ (5.1% vs. 2.7% and more later).
  • Due to its superior profitability, it is no surprise that STOR also delivered superior performance than VNQ.

STOR versus VNQ

Source: Author based on data from Seeking Alpha

STOR Equity Portfolio Returns

Source: Portfolio Viewer

Risks and Final Thoughts

Note, however, that you must be able to withstand the higher price volatility of STOR than the sector fund, which brings us to the last checkbox on our list. If you don’t feel comfortable with company fundamentals or are concerned about day-to-day price fluctuations, stay within your circle of expertise and don’t buy the stock in the first place.

To conclude, this article is most likely our last article on STOR. Congratulations to STOR shareholders for receiving an excellent acquisition transaction. And our best wishes for the STOR business, the best in the new Oak Street family. And finally, we urge all investors to develop a checklist to guard against their own investment weaknesses and blind spots – everyone has them. And if you think you can rely on your wits or willpower to overcome them, chances are you’ll just repeat them. You need a MECHANISM more than anything else, and a good checklist is the easiest and most effective mechanism in our experience.

I hope our following checklist helps you identify other opportunities like STOR!

  • Don’t bet against Buffett.
  • Our odds improve dramatically if we can get below the “Buffett price”
  • The Buffett price should always be interpreted in the context of risk-free interest rates.
  • Don’t confuse diversification with diworsification.

Sallie R. Loera