Saturday, May 23, 2015

Review of The Sleuth Investor: Uncover the Best Stocks Before They Make Their Move by Avner Mandelman

On my second read of The Sleuth Investor, I realize that this is more than a how-to, it has something profound to say about epistemology of investing. The thesis, as he puts it, is:

To make money in the stock market, it's not enough to rely on public information. You have to act like a sleuth. You must probe behind the printed surface of SEC files, annual reports, and press releases, and sleuth for those concrete facts that reveal the truth about a company's real value - and its future.
The book emphasizes the how-to of sleuthing, but he has some very profound philosophical thoughts about investing:
"Most investors... think of stocks as mere symbols and data, and invest in them based only on second- and thirdhand information, which they then manipulate by spreadsheets and computer models and logic and theory.

Most hedge funds invest solely based on secondhand symbolic information...

All these money managers see the same secondhand data that everyone else sees.

The edge in investing is not in manipulating data better, but in getting exclusive data."
His method of obtaining exclusive data is - perfectly legal - "sleuthing". This is something that John Hempton does too, whether he is visiting an Herbalife "nutrition club" or visiting Chinese companies to check whether they even conduct business. Reading Hampton's Herbalife posts makes me wonder what Bill Ackman could possibly be thinking.

Sleuth Investor contrasts sleuthing with conventional financial analysts who are "taught to think about symbols and relationships among symbols" and advises investors to "go to the physical reality behind all of these representations" of the type that people are reading on their terminals.

In The Small Cap Advantage, Brian Bares puts it another way:
"The key determinants for predicting the future earning power of a company are actually qualitative. Factors like competitive positioning, industry growth, and the capital allocation ability of management are not adequately captured by simple ratios."
No evergreen investment strategies. Superior returns come from being on the cutting edge, or in areas that investors are ignoring for some other reason. We can classify some of the strategies that still work in 2015:
  • Nate's Oddball Stocks can work because they are so small and illiquid that no one is paying attention to them. Similarly, Sleuth Investor likes stocks selling below the minimum market capitalization of small cap funds.
  • Sleuthing. Sleuth Investor concedes that these opportunities will tend to be small, because only at a small company is it possible to make a physical observation that has real bearing on the value of the company. But I can think of exceptions, like Hempton's visits to Herbalife clubs. Another one that should have been sleuthed is Molycorp. What would someone find out on a visit to isolated Mountain Pass, CA?
  • Equity yield curve or "time arbitrage" which is what Horizon Kinetics practices. I think it is going to take a long, long time for purchases made in a mania to pay off though.
  • Going to cash during manias. We've had three in fewer than 20 years, so you would think people would start to catch on. Look at Hussman's charts showing cumulative total return when market conditions and valuations are less favorable. 
  • Market anomalies that are not yet being systematically exploited. Volatility. Net stock and debt issuance versus repurchases
You can think of sleuthing as a chapter in a book on systematized exploitation of market inefficiencies.



bjdubbs said...

the sleuth investor might work with a company like gt adnanced, the apple supplier that went under. but 99 percent of the time the sleuthing - finding out who is ordering a big catered party - yields uncertain results.

there is actually quite a bit of info already public. the more interesting sleuthing case is finding out which qualitative data already in the filings or other digital sources is valuable.

CP said...

GTAT is a good example. I wonder if they gave tours and I wonder if it would've been possible to tell the place was a mess?

CP said...

A company that's a huge bet on or at one geographically distinct proposition lends itself to sleuthing: GTAT, MCP.

Remember the GMX Resources sleuthing?

innerscorecard said...

Hell, with GTAT, simply reading the annual report and Googling what happened to the prior record of company management would have been more sleuthing than most investors did, and would have quickly turned up red flags.

And naive sleuthing can be dangerous. I did hear of someone who did do a cursory visit of the Mesa facility - but it looked busy and active. Active questioning is necessary in such a situation.

Anonymous said...

How is this different from the "scuttlebutt" written about in Common Stocks, Uncommon Profits?

Josh H said...

Seems like a contradiction talking about timing the market while pointing to Hussman who really has been market 100% hedged since the S&P was at 1400. He has missed 50% of the move since then.

I know that it is easy to pick on someones record after the fact.

My record into this runup has been poor, but I covered/stopped out/rolled positions higher etc. It also helps that my short book is not index options and disaster stocks (many mentioned by you like WLT, MCP, etc).

Mr. Gotham said...

@Josh H

Can you elaborate on the comment about stocks like WLT and MCP?

CP said...

CP said...

Apr 3, 2013
“If they got their act together it wouldn't be half bad. ”
"Feast of famine with workload. Disorganized management. Company wastes a LOT of cash"

CP said...


"Long drive, bad executive decisions (both locally and corporate), mismanagement of construction resulting in costly delays, overages, bad engineering, and poor QA/QC of construction."

"they reward there shifters and bosses according to amount produced , so if something breaks or if a product goes out of spec , instead of fixing the problem or adjusting procedure to get it back in spec. they just run full speed or duct tape the problem so they can get there numbers out and leave the real problem for some one on the other shift , and of course the other shift runs the same way so it never gets fixed or corrected until millions of dollars are spent reworking product hat could have been fixed from the beginning"

"Basically everything about the place. Horrible management. My boss was not even my technical boss, was not qualified to manage or run a laboratory and made it a nightmare. The laboratory was whofully understaffed and needs a management structure and more people for the amount of work the facility expects. Coworkers who drag their feet and expect you to pick up the slack or do their duties. Take a look at the other reviews. A laughable operation going on. I hope it doesn't fold in the way many predict, for the sake of the men and women who work up there."

"The most technically incompetent and unethical organization under the sun. Spent $1.5B+ to build Project Phoenix , misrepresented to investors that they knew what they were doing technically, but eliminated the technical staff. Fired the entire mining department when the drilling program didn't produce the desired expanded resource results. Operations is a bunch of clueless mining folks with chemistry or metallurgy degrees that don't understand the process and lie to Sr. management about everything and blame everyone but themselves. Stock is down 70+% in a year and they have no idea how to identify or prioritize the projects necessary to succeed. Anyone decent that can escape already has. This will go down as Enron II after bankruptcy."

"From a safety perspective this place is the worst... people by pass safety interlocks and other safety devices and cause spills of hazardous chemical with no consequences, where any other company has zero tolerance. No wonder this place was shut down by the EPA in the late 1990's."


Mr. Gotham said...

These Glassdoor comments are exactly what you would expect to hear from a company struggling to get a plant operating within spec as discussed on the November conference call

"if a product goes out of spec , instead of fixing the problem or adjusting procedure to get it back in spec. they just run full speed"

"was not qualified to manage or run a laboratory"

"a bunch of clueless mining folks with chemistry or metallurgy degrees that don't understand the process"

From the Nov 14 Earnings Call:

"to make sure that we don't end up with product that's coming at the other end that's not exact or that we're having issues with things failing that are going to hurt us later"

"I guess what we're trying to do here is we're, our focus is about building a process, a sustainable process to make a quality product"

Pretty evident they still haven't figured it out. When is Oaktree going to bring in some guys who can run the process right?

Josh H said...

@Mr. Gotham,

Sometime ago it became obvious to me that many investors look at a stock like WLT that is down 50% and dream of it getting back there. The buy the dip calls seem to get louder as it goes lower.

I think this quote helped me a lot in that once a stock is down a lot could very well go lower.

"What do you call a stock that's down 90%? A stock that was down 80% and then got cut in half." -David Einhorn

I only got involved in WLT at 7, which was approximately a year ago. At the peak it was 130-140 and I am sure most people would say are you crazy getting short at 7? 7 to 0 is still a 100% return minus borrow costs. With options, you can also lock in the implied borrow rates. If memory serves me correctly I locked in a borrow at 8% annualized. You can't do this now unfortunately and my position with WLT is almost gone.

The main thesis is that WLT could not survive its debt burden at current prices. The bulls were screaming that prices would go higher but I could not figure out why, little supply was being cut and new supply was coming on fast. I actually thought there was a decent chance pricing would go lower (although not needed for the bk case) and pricing did in fact go lower.

I mentioned that CP has already covered MCP and WLT very well here. Using the links on his site, there are plenty of articles.



Or you can see my comments on Seeking Alpha specifically on WLT below. I double checked on seeking alpha and did not make any on MCP

Hope that helps!

CP said...

Fire breaks out at Mesa Apple facility

"Firefighters responded late Tuesday morning to a large industrial fire at a southeast Valley warehouse that formerly housed a supplier for Apple."

Taylor Conant said...

Re symbolism, I read some Wall St research years back that was literally about changes in the rate of change of some variable. It struck me as an attempt by brainy, mathematically minded ibankers to apply their calculus knowledge to their investment practice (derivatives of derivatives!) and it represents the absurd focus on symbols as opposed to real things. You're simply studying statistical coincidences when you're looking at delta-delta items, it's happenstance, luck, but the desire to pattern-search there results in the delusion there is a meaningful relationship to uncover.

CP said...

Schroeder: I don't think he would have been as successful because the two things that he did don't work today. One is, there was a lot of shoeleather involved. He would do the work that nobody else bothered to do. He would go down to some state insurance department basement and dig through records that no one else was looking for. Now everybody has access to everything, and so the diligent are no longer really rewarded the way they used to be.

The second thing is that Warren was uncommonly good at going around and talking to management and getting them to tell him what their business plans were. That used to be perfectly legal. In fact, the insider trading worlds have evolved, and I wrote a long footnote about it in the book, but he used to basically be able to get and trade on inside information, as did everyone in those days. He was great at finding out if there was a tender offer coming or something like that. You can't do that anymore.

Taylor Conant said...

Epistemological question is that if outsize returns over time come from unique information, and the development of information technology and regulations have severely constrained this unique information, where or how can an individual (legally) source this advantageous information edge to obtain outsize performance and avoid the doom of running with the herd?