I have been passionate about unearthing inferences from the obvious that are in plainsight for a really long time. Like sherlock holmes or newton, everything is in plain sight - it’s just a lot of us refuse to connect the dots to infer the obvious. Some of these are so obvious when someone states them in hindsight that you kick yourself on why you could not get it earlier.
In a raging bull market, a lot of this might sound like preaching celibacy in a harem but I have found out that eventually, the tide catches up and a lot of people (everyone thinks they won’t be the last one on the titanic) are left naked.
No one taught me this topic and I learnt all of this myself by watching videos and connecting the dots myself - I have never read a book either on this topic. A few principles I have always used are
separate the fundamentals from the stock price (just because a stock price has run up 30 x it does not mean the company is not a fraud - satyam ran for 15, maddoff ran for 31 before the end came. Infact, longer the run, the more catastrophic the consequences are when the bubble bursts).
Materiality - focus on the most material parts that add to the value. For eg., in satyam’s case it was the Rs. 5000 Cr. of cash
Focus on areas that can be controlled by the promoter - for eg., auditors, rating agencies, neighbourhood bank managers, CFOs, creating provisions are much easier to get a handle on. Much easier to forge for eg. certificates of recognition, import export trails etc.
inductive reasoning - you only need to disprove one material point to prove a fraud. Sort of like cricket - where any ball can get you a wicket. As a converse, any number of tangential data points does not disprove the issue - for eg., promoter is doing ethical, treats employees well, has a reputed standing, has a lot of skin in the game etc. etc. are all tangential to for eg., examining the cash on books.
ability to keep calm inspite of a barrage of hate mail and negative feedback loops - the greatest short sellers had to call out the emperor’s new clothes against companies like enron (fortune 5), world com, satyam (sensex stock) in the wake of multi decadal track records, a near iconic status of the promoters. whatever people in the world might say, 2 + 2 is a 2. And if a 2 is missing, 2 is missing.
A few samples, one can read are
- confidence game (bill ackman bringing down MBIA over six years)
- Fooling all of the people (david einhorn)
The key to this entire game is to think like an owner and look at the trail that every single activity leaves behind. If you think carefully,
- Sales leaves behind an excise/sales tax issue
- cash leaves behind “other income”
- employee expenses leaves behind PF, ESI expenses
- exports causes forex flow into EEFC
these are first level checks. The second level checks that far more sophisticated and involve mind maps involve understanding if it is indeed possible to even have those kinds of businesses. For eg., if one is a bottler to coca cola, its unlikely you can have an ROE of 30 % + - why - because coke, the brand owner has an asset light business that itself earns only below 30 %. Of course, there are exceptions- also driven by time. What might look like a great business today might get upended 5-6 years down the line.
This is a video that’s a good start - note how he repeatedly uses triangulation - viz., another data sourceto check on the authenticity.
This is a start - I intend to cover one topic at a time. For eg., cash on books, income statement, expenses, provisions.
any brickbats always welcome