The Art of the Scuttlebutt – Why Games Workshop succeeded while Hornby and Stanley Gibbons failed

Knowing how to ask the right questions is a very important skill when doing scuttlebutt i.e. investigative reporter type research into a stock. Phil Fisher, Warren Buffett, Peter Lynch and Keith Ashworth-Lord were/are all practitioners of the scuttlebutt.

I have however learnt the most about scuttlebutt from Geoff Gannon from Focused Compounding Capital. Here is a summary:

  1. When doing scuttlebutt, you never ask a hypothetical questions like “at what price would you stop buying this?” Everyone lies when you ask that. They do not know they are lying, but they still do. When doing scuttlebutt, what you want to ask about is always behaviour rather than opinion. Never ask for someone’s opinion. Always ask about how they behaved in the past, why they think they behaved that way and what might change their behaviour in the future. Always try to frame things in terms of preferences. People are more honest if you do not simply ask if they like the colour blue. Instead, say: “Quick, blue or orange? You have to pick one now.”
  2. If you have to ask predictive questions – here is a tip. When polling people, it is natural to ask questions in the form of: “Which candidate do you expect to vote for in the presidential election?” and “How much less gas do you think you would buy if it cost $6 a gallon?”. Do not do that. Instead, ask: “Who do you expect your neighbour will vote for in the presidential election?” and “How much less gas do you think your adult son would buy if it cost $6 a gallon?”. See, people do not think quite as highly of the consistent rationality of their neighbours and adult children. Everyone thinks they are rational. No one is quite sure the rest of the world is. People have self-images that need to be protected. It is an automatic reflex. So if you have to ask a question where someone might express an opinion that seems emotional, irrational or not the “right” answer, you need to let them save face and distance themselves from such a decision. Make it easy for someone to tell you hard truths. So depersonalize the situation. If you suspect a loan officer would make poor decisions at some point in the cycle – talk to him about what he thinks the average loan officer in the organization would do, not what he would do.

Games Workshop, The Character Group, Hornby and Stanley Gibbons are all “hobby” stocks in the UK.  Here is a chart showing their performance over the last 10 years. Games Workshop has been a great investment. Character group has been a very good investment.  Hornby and Stanley Gibbons have been poor investments.

Games Workshop designs, manufactures and sells fantasy miniatures and related products. Its most popular product is Warhammer. Character group designs and distributes  toys based on characters on television and film. Its most popular product is Peppa Pig. Hornby designs model train sets and locomotives. Stanley Gibbons sells collectibles like postage stamps. Why has games workshop performed much better than the other stocks? What variable accounts for the success and failure of these companies? Competition. I am not talking about competition from similar products. To really understand competition in this case, you need to understand what exactly drives demand for these types of products – and that is the attention economy.

A child living in the 70s, 80s or 90s had limited competition for his/her attention. The options were – watching TV, playing with toys, playing with friends or reading a book. Children now have another competitor grasping for their attention – the internet. More specifically – YouTube. To do scuttlebutt on a stock like Hornby, you can ask your children or your friends children how much time they spend on YouTube versus playing with toys. The phrasing of this question is very important. You must ask about past behaviour and not what they prefer because if you do the latter, they may try to give you the “right” sounding answer. From the people with kids I have spoken to, most of their time is spent on YouTube over playing with toys. This is the main competitor of Hornby, not other toy or model manufacturers. This doesn’t mean that people will stop buying model trains from Hornby. However, less people will so its normal earnings power has decreased.

The character group is a good company because it designs toys based on popular TV characters. The product it chooses to design already have a metaphorical contract with its customers. So if a character like Peppa Pig is popular, it will try to get a license to design and sell Peppa Pig toys. However, Hasbro has recently acquired Entertainment One who holds the license to Peppa pig. Character Group’s license only lasts until June 2021. The literal contract that Character Group had to design Peppa Pig toys has been broken and its share price has suffered in the short term.

What type of Scuttlebutt would tell you that Games Worksop is different? Here is a comment from an FT article. Emphasis added.

“One of my sons plays Warhammer.  He was at a friend’s house one day and asked what the models were, got involved in a game, and it went from there. The models can be quite expensive – my son spends more of his pocket money on them than on any other thing, including computer games.  For a slightly hyper child, the attention required to paint the models is a pleasure compared with the bouncing seen when he plays video games. I echo the article about the way in which the shops are run.  I’ve been in several now and every single one has had a manager (usually just one or two employees per shop) who is genuinely enthusiastic about Warhammer – I’ve almost been tempted to have a go myself, but I simply don’t have the time.  It’s a real pleasure to come across that level of engagement from shop staff compared with the usual disinterest on the British High Street.”

From this we can tell that some customers are price insensitive and the stores are well run and cost efficient (only one or two employees per shop). A further comment from Games Workshop proves the latter point.

“We didn’t hire ordinary retail people who’d worked at Sainsbury’s or Marks and Spencer. We hired other people like us. We were hobbyists and games players ourselves.”

Their retail staff are also players of Warhammer meaning they are enthusiastic and well informed – the two best attributes of a sales person.

If you look at the past financials of Games Workshop before 2015, it is not particularly impressive. Between 2005 and 2015, revenue fell by 13% in nominal terms. The company was shrinking. Things picked up in 2016 when a new CEO took charge. There is a Bill Miller quote that highlights the importance of strong qualitative research: “All the information is in the past, but all the value is in the future”. From its historical financials, its would have screen as a good company, not an exceptional company. However, speaking to people and asking the right questions would have shown that its customers love their products and are somewhat price insensitive. What are the risk to the company going forward? Competition from other aggregators of attention – other board games or YouTube/the internet. From my understanding, the “hobby” stocks that perform well will have a network around the individual customers. Playing with model train sets or collecting stamps is largely a solitary hobby. Playing Warhammer, whether online or offline relies on interaction with other people. This is a strong force that can keep people coming back as it builds a sense of community.

Ultimately, determining whether the moat around Games Workshop is strong depends on understanding consumer behaviour. And this means doing scuttlebutt research and asking the right questions.

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