The scuttlebutt method of stock research
Phillip Fisher – one of the great investment gurus of all time – used to talk about the “scuttlebutt method” - just finding out what is really going on in companies by asking customers, suppliers and competitors. Information that comes from the company is either inside, self-serving or both. Sure you need to read and analyse accounts but real information – stuff you dredge up on your own – creates an edge. Obviously if that real information comes from paying insiders (or supplying sexual favors to insiders) then trading on that information is illegal (and the SEC/FBI are getting a string of guilty pleas).
However this is a post about research methods that might be used by semi-professional investors – those that could not afford the services of the “expert networks” at the core of the current batch of insider trading cases. I am exploring what might be a common position after some (really diligent) research. It is a position we find ourselves in.
We know a company with a moderate market capitalization (a few hundred million dollars). There is no short interest – and there are (highly) reputable people on the board. Board members “check out”. Nobody has a history in pump-and-dump schemes – the board seems suitable.
The stock is widely distributed having been well promoted by regional stock brokers. Whilst the stock has been weak for a long time nobody has shorted the stock because the upside if the technology works is very large. Given this is an adventurous technology I would normally expect it to fail – and the company to fade into obscurity. Most adventurous technologies fail – and failure does not reflect badly on management. Still the management is upbeat and a bullish release is made about once a month.
The company is not located in well-known technology centre – its in somewhere like Kansas rather than somewhere like San Jose. Indeed there would be almost no cross-fertilisation with other companies in this industry because there are no competitor companies for hundreds of miles around.
The company sounds promising. It is in a major industry (with a huge end market). The technology was mainly developed by the founder. The industry (more broadly) is conducting a lot of research and development along a lot of distinct technological lines. None of the serious players seems very interested in this line. Nonetheless the technology has had favorable mentions in top-class science publications (like Nature). Cumulative R&D spend is about $30 million which the company has raised by issuing stock. The founding CEO claims a PhD from in a relevant area from one of the top universities in the world. (I have not checked this PhD was actually awarded.)
The company has a factory which has a working (and clearly polluting) smoke stack. (I know because I paid someone to observe it.) The company is however primarily an R&D shop so you would expect typical nerds to work there – starting late and ending very late (tech geeks keep often keep very odd hours). However my spy tells me the car park is largely empty by 5pm which is unusual in a tech-research company where the end-goal is to change the world.
The company has sales – but the sales are to another R&D company in the same (relatively obscure) sub-branch of the industry. There are no sales to real end customers but the company touts its sales. The product is – as far as I can tell – not in commercial use though pictures of samples are on the website. Ambitious technical claims have appeared – and later disappeared – from the corporate website. I have – through a proxy – asked for a sample and not been given one. The proxy would normally expect to receive a sample as he is potentially a large end-user.
The founding-CEO was CEO for about a decade. He is now just shy of 50. He became executive chairman a while ago and appointed a guy with a fine manufacturing career as CEO – but the manufacturing career is from a completely unrelated industry. That CEO lasted about two years before he moved to a lower paying (although still CEO) job. He gave up his options without much dispute. The founding-CEO claims to be involved and claims to be attending all the board meetings.
Now I discover the founding-CEO is living with his mistress more than twelve hours flight from the working-class locale of the main R&D shop. The mistress is substantially younger and the new locale is exotic (think South of France, Tahiti or Byron Bay Australia or similar). The mistress has a daughter by an earlier relationship and hundreds of thousands of dollars are spent on the daughter's glamorous hobbies and lifestyle.
Finally the founding-CEO's teenage son hangs around the original town and uses a high-priced sports car to (seemingly successfully) attract girls. Money drips out of the son's pocket and the son has an entitled demeanor. The dad of one of said girls is suspicious – but maybe he is only protecting his daughter.
Knowing only this much about the company how much weight would you put on the founding-CEO's lifestyle decision as to whether to go long or short the stock?
My second question: suppose you met this founder-CEO in the lounge at the airport waiting for the first-class flight to the above exotic location. Because of your interest in this company you recognise the founder-CEO from the photo in the annual report. You find out in casual conversation that the founder-CEO was going “home” to the exotic location. Most the rest of the material you found by befriending people on Facebook (using your real name). Would this method of research be kosher?
Finally – is this what Phillip Fisher (Common Stocks and Uncommon Profits) thought of as the “scuttlebutt method”? What is the line between what Phillip Fisher thought of as “scuttlebutt” and what the SEC is currently thinking of as insider trading? Is this sort of scuttlebutt sufficient to beat the market anyway?
Thoughts please.
John
PS. Thanks for the correction: Phillip Fisher at the beginning of this article turned into Ken Fisher at the end of the article. I confused father and son.
J