Little things can mean a lot, and you’ll be a better investor if you develop the sensitivity to trace evidence that something is amiss, be it a line in an annual report or a minor shift in business strategy. In the late 1990s, for example, Warren Buffett noticed a footnote in Freddie Mac’s annual report stating that the mortgage company had entered the subprime loan market. Instead of calling the firm for clarification, Buffett decided, based on that single footnote, that Freddie was now a different—and potentially riskier—company. He sold all of Berkshire Hathaway’s holdings in Freddie when the stock was in the $60s, ultimately saving his company $3 billion. Freddie, which is in receivership, now trades for 29 cents.
Dubious Deals
It’s taken a long time, but I’ve gradually learned to act on my instincts. When short sellers first targeted Tyco International, the always-acquisitive firm announced three major deals in a matter of months. What? I said to myself. Had three huge buyout candidates materialized at once, or was Tyco really doing the deals for dubious accounting reasons, as critics alleged? Instead of selling immediately, I nervously watched with my finger on the trigger. Eventually I sold the stock in the $30s, bought it back in the teens and sold it again in the $30s.
In recent months, I’ve lost confidence in a tiny company I hold called iGo. Profit margins have cratered as competition in iGo’s core business, electronic chargers, has intensified. During a recent conference call, CEO Michael Heil said he would address the problem by investing more money in the charger business. Ping! Wrong answer! This will likely be money down a rathole. Yes, the company, which has a market value of just $21 million, could still do well because of a deal it has with Texas Instruments to co-develop power-management chips that use iGo’s technology. But I think iGo’s management is wrongheaded, and I have lightened my position (though I continue to hold some shares in case the chip turns out to be a big hit).
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Of course, I don’t pick up every clue. The worst stock I ever suggested in these pages was Live Current. When it came to the firm’s Internet cricket business in India, I, like an inept batsman, took my eye off the ball. The CEO kept talking about how popular this new form of cricket was and how Sony had paid staggering sums for the TV ad rights. Both true. But I failed to notice that he always talked about cricket on a big-picture level and seldom offered specific details. The bottom line? There was no bottom line. In fact, there was hardly a top line: Live Current invested millions of dollars and produced almost no revenues. I wondered not only how this could be but also, more important, how it could have happened without my noticing. With every stock you own, the details of the company are much more important than the big picture. I should have heard what wasn’t being said and sold Live Current sooner.
I sold another of my bad recommendations earlier than I might have partly because of how its CEO butchered a word. Bruce Eskowitz, former CEO of Premier Exhibitions, was a spendthrift who always talked about the ancillary benefits of his deals. Just two problems: First, I never noticed any of these ancillary benefits. Second, Eskowitz always mispronounced the word, saying an-SILL-a-ree, rather than AN-se-lair-ee. Granted, I’m a pronunciation snob. Still, I think it is dumb for a CEO to use a word that he can’t pronounce a half-dozen times.
We all need to keep our antennas up. Important messages are sometimes crystal-clear, but often they get muffled via footnotes, offhand comments and corporate doublespeak. When a biotech company says that regulators just rejected its cancer drug, but—wait!—it might do wonders for sleep apnea or acne, you should hear a ping. If not, you should have your ears, and your portfolio, checked.
Columnist Andrew Feinberg manages a New York City-based hedge fund called CJA Partners.
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