Another way I caught an 'inflection point' in a fast-food stock; St. Andrews and the Scottish Highlands

1) It may have been rude of me to interrupt a CEO's lunch to form an investment thesis. But boy, was I sure glad I did so...

It all had to do with the concept of getting a "variant perception" – a belief that a company will perform much better than most investors expect. That means having a unique piece of data, insight, or analysis.

And that's what happened with me back in early 2003 with now-private CKE Restaurants, which owns the Carl's Jr. and Hardee's fast-food chains...

CKE previously used to just own and franchise Carl's Jr., which management had fixed and turned into a great business.

But then, filled with hubris from this turnaround, it made the terrible decision to acquire what was widely considered to be the worst fast-food chain in America: Hardee's.

The chain wasn't known for anything in particular – it served roast beef sandwiches, fried chicken, and burgers – and didn't do anything well.

As the legendary Warren Buffett once said:

When a manager with a reputation for brilliance tackles a business with a reputation for bad economics, the reputation of the business remains intact.

And that's exactly what had happened with CKE.

Management utterly failed to turn around Hardee's, and its poor performance – and the debt CKE took on to buy it – nearly bankrupted the company, crashing the stock from $12 per share to around $4 per share.

At that price, I calculated that CKE was valued at roughly what Carl's Jr. alone was worth and getting Hardee's for free. So I figured I couldn't lose – and, with the stock down so much, it couldn't possibly go any lower, right?

Wrong.

It was a similar case with McDonald's (MCD). As I explained in yesterday's e-mail, MCD shares had plunged from around $44 in 1999 down to around $16 per share near the end of 2002 before a few more months of negative same-store sales sent them below $13.

The same happened with CKE – and the stock was soon approaching $3 per share.

And, as with McDonald's, my instinct was to buy more for my fund. But before doing so, I wanted to do more work to confirm my investment thesis. So I arranged a meeting with the investor relations person at the company's then-headquarters in Santa Barbara, California and hopped on a plane...

And lastly, as with McDonald's, I got lucky – but also created my own luck – which led to making a killing.

The meeting I had flown out for with the investor relations person was a bust – I didn't learn anything of interest.

So afterward, I went across the street to have lunch at the Carl's Jr... And halfway through my meal, I noticed CKE's then-CEO Andy Puzder meeting with someone over a burger.

I was hesitant to interrupt... but I eventually decided to approach him and introduce myself as a shareholder who had flown across the country to learn more about his company.

Puzder might have been impressed by that – remember, CKE's stock was in the toilet, so I'm sure few investors were showing an interest in it – so we ended up engaged in an in-depth conversation as I peppered him with questions.

He was super enthusiastic about his new idea, which was just underway...

It was to take the thick, juicy Angus beef burgers called Thickburgers that were a hit at Carl's Jr. and also sell them at Hardee's.

Now, this plan was already well known. And I (along with most investors and analysts) expected that it would turn out the same way all the previous turnaround plans had – with failure.

But when I expressed this widespread skepticism, Puzder said, "Come with me," and took me back to a conference room in the headquarters building and played 20 minutes of videos of focus groups the company had commissioned.

Each focus group was eight to 10 Hardee's customers who had just tried the new Thickburgers – and they were going nuts for it. They were accustomed to lousy, cheap food at Hardee's and were delighted by the delicious new menu item, even at a higher price.

I started to share Puzder's enthusiasm, but still wanted to do my own work to validate what the focus group participants were saying. So I asked if he could provide me a list of all Hardee's restaurants around the country. He did, and when I got home, I started calling them.

The manager or assistant manager usually picked up, and I said along the lines of:

Hi, my name is Whitney Tilson. I'm an investor in your company and just met with your CEO, Andy Puzder. He told me about the new Thickburgers you've recently introduced, and I'm wondering if you could spare a few minutes to tell me about them?

Almost everyone said yes (I made sure to call during off-peak hours), so I asked how the Thickburgers were selling, what customers were saying, and how they were affecting the revenues and profits of the restaurant.

After two dozen calls, I was hearing a consistent story...

Initially, customers were surprised and disappointed when they came in and learned that fried chicken – an inexpensive way to feed a family – was no longer on the menu.

So in the first few weeks of the Thickburger rollout, sales initially dropped. But then existing customers – and, critically, new customers – discovered the new burgers, and sales quickly recovered and started to grow. And, more importantly, the new burgers were priced higher, so profits grew even faster.

This was a dream setup.

Investors were seeing declining same-store sales and punishing the stock, but now I realized that this was good news. It reflected the fact that Puzder was putting the pedal to the metal in rolling out the new Thickburger menu across all Hardee's.

As my "scuttlebutt" research revealed, this caused their sales to initially drop, but now I knew what was about to happen in the very near future across the company: sales were going to turn around and profits were about to explode.

So I backed up the truck, buying shares of CKE as low as $3.12. And then exactly what I anticipated happened and the stock doubled, then tripled, then quadrupled.

I eventually started selling the stock at $13.18 per share months later in July 2004 and finished selling at more than $15 per share in early 2005. (It was a good sale, as the company was taken private in July 2010 when Apollo Global Management bought CKE for $12.55 per share in a deal worth an estimated $1 billion.)

As I've been saying in my recent e-mails, you ultimately only need to find a handful of setups like this with "inflection points" in a lifetime to achieve big success with your investing.

And to do so, pattern recognition is critical.

That's why I've been spending so much time sharing case studies from my career, like the A-class shares of Berkshire Hathaway (BRK-A) on Tuesday and McDonald's yesterday.

Overall, there are a number of important lessons here with my CKE story (and my experiences with Berkshire and McDonald's)...

Most importantly, to really make a killing, you need to have an edge. When I initially bought CKE's stock – as with McDonald's – I did so based solely on the numbers, which told me the stock was cheap... but I didn't really understand the company.

So I initially lost money – and deservedly so.

The key is what I did next, when I was down 25%. I didn't panic and sell. But neither did I rush in and buy more.

Instead, I did more work. And frankly, it's what I should have done before buying the stock initially. I focused on gaining an insight into the company – information that other investors wouldn't have.

And then I got lucky. I might never have gotten conviction about the Thickburgers and CKE's resulting turnaround had I not bumped into Puzder.

But I also created my own luck – along the lines of the old saying, "The harder I work, the luckier I get."

I never would have met him if I hadn't flown across the country and shown up at the company's headquarters. It reminds me other another quote, attributed to hockey legend Wayne Gretzky: "You miss 100% of the shots you don't take."

And here's one final lesson – on selling...

Regular readers know I'm constantly preaching that "you must let your winners run." But that only applies to high-quality businesses that are long-term compounders, like Berkshire Hathaway and McDonald's.

CKE didn't – and never will – hold a candle to McDonald's.

Well run, it's at best a decent business. It's OK – and sometimes highly profitable – to invest in such businesses, but only when there's a catalyst such as breaking up the business or selling part of it, a turnaround plan, a new CEO, etc.

Then, when the catalyst plays out (hopefully in your favor), you need to sell!

(It reminds me of what one airline CEO told me: "You can't own airline stocks. You can only rent them.")

2) As you read this, I'm on a flight from London to Boston...

After my flight, I'll be catching a bus this evening to Dartmouth College in New Hampshire to attend my oldest daughter's graduation from Tuck School of Business this weekend.

I don't arrive until midnight, which is 5 a.m. London time, so it's going to be a long day!

Wrapping up the Scotland trip, after two days touring the wonderful city of Edinburgh, yesterday my parents and I rented a car and did 225 miles of driving over the course of the day.

We first took the coastal route two hours to historic St. Andrews, where we visited the castle, cathedral, university, and golf course.

Then, we drove north to the Scottish Highlands and visited a famous scenic overlook called Queen's View and visited many charming towns before driving back to Edinburgh and taking a late flight to London.

This morning, we took an Uber Boat on the Thames River before I went to some meetings while my parents toured around. Then we both headed to the airport for our respective flights home. Below are some pictures (I've posted more on Facebook here):

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.