Readers continue to chime in with their own Tips for the Timid, a series that was launched here a few weeks back with my 10 tips for trying to spot trouble. This week's offering, courtesy of money manager Jeff Matthews of Ram Partners -- one of this column's regular contributors -- is too valuable not to read. It's a list of just three items, but they include a few classic war stories and provide insight into how a professional skeptic thinks.
- The "Tape Measure" Rule: "Or, the thicker the investor package, the less legitimate the company. This may sound incredibly shallow. But it is (no joke) a 99% accurate leading indicator of corporate trouble. Go try it yourself -- visit any investor conference in any industry and check out the investor packages the companies provide. Companies with a simple, clean business have thin, easy-to-read investor packages. Their annual reports are concise and clear because their businesses are easy to understand and explain. Their 10-Qs and 10-Ks aren't burdened by lengthy amendments that come when companies are making lots of acquisitions or changing accounting techniques. And they don't need to fog the air with puffy press releases.
"On the other hand, companies with businesses that are hard to explain usually have thick annual reports with lots of glossy pictures and hype-y verbiage. The packages also include the dozens of press releases these companies tend to issue, and they also have thick 10-Ks and 10-Qs that come with companies doing rollups or acquisitions. If they're technology companies, they'll include 'white papers' about arcane nonsense that nobody really understands; if they're medical companies they often have sales material for revolutionary new products that never get through the
"Examples? Well, from the 'great company' category,
Exxon (XOM) - Get Report and
Mobil always had the thinnest annual reports in the oil sector;
Price Club and
Costco (COST) - Get Report in the retail sector;
Intel (INTC) - Get Report and
Microsoft (MSFT) - Get Report in the technology sector.
"In the 'bad company' category, every little oil and gas company that blew up after the oil collapse in 1980 had fat investor kits with a zillion press releases about wells and drilling prospects that never materialized; most of the medical real estate investment trusts and rollups had huge packages because of all the flaky acquisitions they were doing (
Sunrise Assisted Living (SNRZ) being a recent example); and too many small technology stocks to mention here have come and gone, leaving behind some very fancy promotional material.
"It may sound weirdly simplistic coming from a professional money manager who has been doing this since 1979, but I can tell you that great companies do not hand out fat investor packages, and bad companies do not hand out thin investor packages."
The "Does the Emperor Really Have Clothes?" Rule": "When you listen to a company that is currently in a very hot sector speak to a lot of eager believers about themselves and their business, try to imagine how they would sound if their sector was bad and the company had 'blown up.' This helps you avoid the trap of being taken in by the crowd and its ability to overlook flawed businesses simply because they happen to have good stock charts at the moment. You're trying to get at whether the guy really makes sense because of what he is saying and what kind of business model he has -- or whether he sounds good because he just happens to be in the right space at the right time.
"For example, I defy anybody to sit in a breakout session with John Chambers of
Cisco (CSCO) - Get Report and imagine him speaking to a half-filled room of analysts who think he's an idiot because his stock has collapsed and his business model is under attack. He makes too much sense, and he's smarter than anyone else in the room.
"But I remember going to see Dennis Kozlowski of
Tyco (TYC) fame for the first time -- it was at a conference just after the stock got hit last fall over accounting issues. I had never seen him speak before (I don't watch
CNBC), and as I sat there in a room full of institutional investors who were obviously still long the stock and hopeful that the issues would be resolved favorably, I was amazed at how shallow his presentation was ('this is our medical business, we raised margins in it last year...'), how weak the logic behind the acquisitions was ('well, we bought
U.S. Surgical and we can offer one-stop shopping for medical products' -- as if hospitals buy medical gear the way people buy food at the
Super Stop and Shop) and how lame the connections between Tyco's businesses were ('we have medical sutures and undersea cables and fire sprinklers...'). I had gone in with an open mind, assuming this guy billed as 'The Next Jack Welch' would be a sharp tack, and I was really underwhelmed. It was easy to imagine him speaking to an empty room of analysts who were thinking, 'This guy is an idiot and this company is a hodge-podge of junk' because the stock had collapsed. Consequently, I'm not short the stock, but I'd never be long it."
("P.S. I never bothered to pick up a Tyco investor packet to confirm my 'tape-measure rule,' but I just checked
Edgar and found that Tyco's 1999 10-K occupied 704 kilobytes of storage; its most recent 10-Q took up 114 kilobytes. For comparison's sake, I checked out the filings for one of the best-run big companies I've ever known, which also happens to be the largest retailer in the world and the largest private employer in the United States:
Wal-Mart's (WMT) - Get Report 10-K was 227 kilobytes; its 10-Q was 67 kilobytes. I rest my case.")
"The Lady Doth Protest Too Much, Methinks" Rule: "Be very leery of companies that provide too-easy access to the CEO, and where the CEO is the prime spokesman for the company, especially when he conducts a jihad against short-sellers.
"In the mid-1980s, I had been keeping an eye on
Regina, a vacuum-cleaner company that was a very hot stock at a time when retail and consumer stocks were doing very well. This was not based on any insights of my own, but I had been warned about Regina, an upstart based in New Jersey, by a guy I'd met touring the
Hoover vacuum cleaner plant in Ohio. This Hoover fellow, a mild-mannered Midwesterner, had responded to my question about what he knew of Regina and what he thought of them, by saying, 'Well, you did know that we got a cease-and-desist order against them for false advertising, didn't you?' No, I didn't know that, nor did any of the Wall Street analysts hyping the stock.
"So I kept my eyes on the Regina balance sheet, and sure enough, one day the 10-Q came in the mail (imagine how quaint times were back then -- waiting for a 10-Q in the mail!) -- and Regina had suddenly developed the key warning signs of impending doom: inflated receivables and inventories.
"I immediately called the company, cold, asking for the IR person (I like to talk to IR people first, to get 'the story' the company is pushing, before talking to the CFO or CEO). Instead, they put me straight through to the CEO. I asked him about the inventories, and he told me their business in Europe was exploding so they had product in transit (shipping plastic to Europe? I don't think so!). I asked about receivables and he told me they were taking share from Hoover in Europe and they had longer payment terms there (a tiny little upstart outselling Hoover in England, where Hoover is so strongly entrenched that the term for 'vacuuming' is 'Hoovering'? Hardly!). He was oily and slick, and I didn't believe a word he said.
"I shorted the stock, as did others who saw the same problems. It became a big battle between the shorts and the longs. The CEO was very public about it, and led the charge against the shorts, but eventually it blew up. But I didn't realize until later that it was a fraud: turned out the company wasn't taking reserves for vacuum cleaners that were being returned by retailers. It was just stuffing them into a warehouse in New Jersey. I think the CEO actually went to jail.
According to news reports, he was sentenced to serve a year in a work-release program after pleading guilty to creating bogus sales.
"This taught me to be very leery of companies that provide too-quick access to the CEO and where the CEO is the main guy who handles investor contacts. Great companies (like Cisco) have great people up and down the chain of command -- and no need to tightly control Wall Street."
Look for another list of tips next week. And this plea to money managers: If you have war stories like Jeff's that have taught similar lessons, please feel free to pass them along. The goal here is to eventually compile these in a way that will help investors. Thanks.
Herb Greenberg writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, though he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at
firstname.lastname@example.org. Greenberg also writes a monthly column for Fortune.
Mark Martinez assisted with the reporting of this column.