When to Sell: Weight Watchers (WW) Case Study
The endowment effect, commitment bias and a brief example
One difficulty in knowing when to sell a holding is the endowment effect - people value what they already own more highly than similar items they do not own. There is also commitment bias - once you’ve committed to a certain course of action, e.g. deciding to purchase a stock, you tend to remain committed. Even worse, if you’ve publicly committed to something, it’s harder to back down and admit you were wrong (this is one reason why I was hesitant to start a blog). This is also a reason I try to stay away from FinTwit / Twitter; while there is some great content, most discussions seem to devolve into mindless polemics, with each side vocally and publicly defending an unyielding viewpoint.
More specifically, although it might be possible to determine if an individual security is severely undervalued, it’s harder to know for certain if it’s grossly overvalued, even setting aside speculative rises (e.g. GameStop) that are completely unmoored from fundamentals. Great companies have a tendency to continually surprise to the upside, and even small but plausible tweaks to growth rates, operating leverage or return on invested capital can have disproportionate effects on valuation.
As mentioned in my 2020 review, I’ve arrived through trial and error at a bifurcated approach to selling:
Good Companies - Companies with good management, wide moats, a long runway of growth, and the ability to compound capital at favorable rates. Don't sell based on overvaluation alone. Good companies often appear overvalued, but have a tendency to exceed expectations. Sell if the "story" changes or if a better opportunity comes along.
Average Companies - Buy when extremely cheap. Sell when cheap, but not necessarily fully valued. These are mostly cyclical or pure value plays. The idea here isn't to be greedy, but to opportunistically capitalize on extreme mispricings.
I wanted to add some additional color to the sell decision with a recent case study.
Case Study: Weight Watchers
Weight Watchers (WW) is one of the few stocks that I’ve purchased this year. Originally, I thought it was just an extremely cheap, but average, company. Although they are more widely known for their in-person, weight-loss studios, much of their revenue actually comes through their digital app. Even with very conservative assumptions, WW seemed to be trading for well under the value of its digital subscription business alone. And assuming any return to normality, you were getting at least some remnant of the historically profitable (albeit dying) studio business for free.
The more I researched the digital subscription business, the more I was led to believe that the business might be better than average. Not necessarily “great”, but definitely “good”, with the potential to compound returns over a long period of time. Furthermore, I believed that 2021 would have the potential to be a banner year, considering the fact that many American’s had gained weight during lockdowns, and that the pandemic had accelerated consumer adoption of digital technologies in virtually every industry. These assessments led me to hold on to the stock even when I thought it was overvalued at $36. The only compelling reason to sell a “good” company was if the “story” had changed.
While doing some more research today, I came across a website that compiles activity for subreddits. The /r/weightwatcher subreddit was fairly active, and I was able to pull out subscriber numbers for previous years:
Although it’s only one source of data, Q1 subreddit subscription growth numbers lined up pretty closely with WW’s full-year reported digital subscriber growth (Q1 is typically indicative of full-year growth, since so many people make New Year’s resolutions to lose weight). The deceleration of growth in Q1 2021 was particularly concerning, especially because it ran counter to my argument that emerging from the pandemic would provide a boon to the digital business. The only explanation I can come up with is that Covid has accelerated digital adoption not only for WW, but for a plethora of other digital competitors (e.g. Noom, MyFitnessPal, Lose It!, Peloton, Strava, etc), lowering the barriers to entry.
For what its worth, management has indicated that they “expect to deliver strong digital end-of-period subscriber growth in Q1,” especially “starting in the last few weeks of Q1” - so it’s possible that these numbers don’t tell the full story. And subreddit subscription numbers are just one, potentially noisy, data point. But I find it hard to reconcile the numbers above with “strong” digital Q1 2021 growth, especially since Q1 2021 should have had the added tailwinds of being in a more physically-distanced, digitally-friendly, Covid-impacted world vs Q1 2020 (which was largely unaffected by Covid). Competitors also didn’t seem to suffer any shortfall of growth.
So, the story had clearly changed, at least based on the data above, but I still wasn’t sure whether or not to sell. Most likely, I was still suffering from the endowment and commitment effects. Fortunately, I had started listing three items for "What would convince me that I’m wrong?” for every valuation, before purchasing any stock.
For WW, these “What would convince me that I’m wrong?” items were:
Flat / negative digital growth
Rising interest rates / inability to refi debt (which might make debt load unsustainable)
Unable to recruit Millennial / younger cohorts necessary for sustained long-term growth (i.e. losing out to Noom)
It was pretty clear that (1) and (3) were at-risk. Re-reading these items quickly dispelled any endowment and commitment effects, and the decision to sell became clearer. Explicitly spelling out the reasons for why I would change my mind, before committing to the initial purchase, made it much easier to change my mind once those conditions were met. Psychologically, it seemed to give me the “freedom to be wrong” - a necessity in a business where it is impossible to pick only winners.
Some final thoughts:
WW doesn’t report Q1 earnings until May 5th, so I have no idea if the analysis above will prove correct. This is not a prediction nor is it investment advice. Regardless of the outcome, the important thing for me is having a repeatable process in place for making sound investment decisions.
Despite (potentially) being completely wrong on my original investment idea, I was still able to make a respectable profit because the initial purchase price was so cheap. This only reinforces the importance of having a large margin of safety. Warren Buffett once said “price is my due diligence”, and a cheap price here may have forgiven many errors of analysis.