$GAW (Games Workshop) is one of my favorite businesses. It's had an amazing run, but when we have such favorable outcomes; it's important to understand the difference between business returns and market returns.

Rapid rises in our holding's value creates problems.

Read on...

In the past 10 years $GAW has doubled it's annual sales from 127m to 270m. Most of this is in the last 3 years. In 2017 Sales were 158m and a year before just 118m.

In addition to growing revenue, $GAW simultaneously increased margins. This is because the new CEO focused on product improvement AND operational efficiency - a big focus was getting the retail part of the business correct.

It unlocked tons of value.

The result is a near 5x increase in FCF despite "only" doubling revenue.

But market returns far exceed business returns.
Price to sales today are 11x higher than 10 years ago (0.85x to 9.64x).

Market cap is 24x higher (108m vs 2.6b).

The implication is investors buying today must believe that the company can do FAR better at improving than it has done in the past - a substantial challenge.

Of course there is the opposite possbility; that it was a far better business than "the market" recognized and now the valuation is more reasonable.

It's not easy to know which is "true;" but "the market" is perfectly capable of mispricing anew, dropping the price substantially.

For the business owner the rapidly rising valuation is unappealing as it forces a decision.

"Should I sell at this price to the bidder who keeps coming back with higher and higher offers or should I ignore them?"

"If I do accept the bid, then what do I buy with the proceeds? If I don't accept the bid do I forgo a time limited windfall?"

This problem of market prices vs business value is why some "old school" investors preach a "never sell" mentality. But this is also problematic.

We saw an example when Charlie Munger was asked about the rapidly increasing market value of BYD (The Chinese auto/energy business). He has a couple suggestions, but no clear answer.

(Seriously, watch the video!).

I suspect Charlie will do nothing because he believes BYD is a great business with a lot of growth ahead of it; and his behavior is pretty well entrenched. But he does surprise from time to time.

But not all companies have such long growth runways...

I like @GAW a lot.
It has a unique product with a fierce customer base. It is well run and doesn't have any major competitors. But while it has managed solid growth over the past few years, it is not clear that is has a growth runway approaching that of a company like BYD.

Indeed, if $GAW returned to a 1x price/sales multiple, it could double it's total sales three time (300m -> 600m -> 1,200m -> 2,400m) while keeping similar margins; and the stock price would not need to budge.

Detractors may say that a company with that kind of growth would never see a re-valuation of this kind.

That is likely true, but growth ends eventually and it is difficult to predict when this will occur - and more difficult in some businesses than others.

Should $GAW growth stop here and FCF stay where they are, a return to around a 1x P/S would represent an 85% drop in market value. Even a return to 5x P/S would cut market value nearly in half - far from an unthinkable outcome.

I believe what investors must do is attempt to ignore these fluctuations, but be prepared to handle the wild swings of valuation the market provides.

One thing we can do is pre-decide to "sell" at a certain "ridiculous value" computed in advance.

One could write down:

"I think $GAW is worth somewhere between 500m and 2.5b, but if someone offered me 3b, I would happily sell it to them."

"range of uncertainty" = 500m and 2.5b, and
"barrier of insanity" = 3b.

Incidentally, I think it's perfectly fine to have a gray area between uncertainty and insanity... this simply reflects the actual feeling you have.

If you like you can give it a name and range i.e.
"range of nausea" = 2.5b and 3b.

This can be whatever you like, but there is always a barrier of insanity.

If someone offered 500b for $GAW I have no doubt all owners would sell. That absurd number is merely there to prove a point. Few people are truly "never sell."

The other advantage of this simple exercise is it requires us to roughly re-value the business at least every year and focus our attention specifically on the market price vs value discrepancy.

We have all likely experienced (or at least seen) companies with high growth experience rapid multiple compression on the mere rumor of slowing growth.

A high price multiple is proxy for market price fragility.

Price matters... sometimes a lot.

I won't comment on whether I think someone should "sell" or "hold" $GAW as that is a complex decision based on many factors. I merely point out that seeing a rapidly rising market value is not always a good thing.

And "pre-choosing" ranges to hold, feel nauseous and sell is likely better than doing it in real time.

We feel happy and smart when our investments increase in market value dramatically, but it's much more important (and difficult) to pay attention to the growth of the underlying business. Large increases in discrepancy create their own kind of emotional and financial problems.

As an investor, I rely on price/value discrepancies to create buying opportunities, but once I own them those same discrepancies are an occasional irritant.

No one said it was easy :).