Over the past two weekends I read the book “Dead Companies Walking” by hedge fund manager Scott Fearon and journalist Jesse Powell. Scott Fearson is a successful hedge fund manager who has generated great market-beating returns for more than two decades. He invests in good companies and shorts the “dead companies walking”.
To Scott Fearon, the “dead companies walking” are the companies that have declining revenues and climbing debt. He usually waits and will not start the short positions until the market has recognized the problems with the companies and stock prices have declined significantly from the peak and continue to slide. In the book Mr. Fearon shared his numerous visits and meetings with the companies he invests (or shorts). He made more than 1,400 visits to companies over the last twenty years. From that readers can get a rough idea how to do investment research to succeed in the investing business. It is definitely not easy and requires a lot of hard work.
The Authors did admit that it is much harder to make money shorting stocks and shorting requires much more work. For short sellers, the upside is 100% but the downside is unlimited. The authors also admit that he made more money from long than from short.
The author carefully studies the operations of companies. Sometimes he would switch from short to long if the operations of the companies turn positive. He did that with Cost Plus, Inc. and made money both ways. Not surprisingly he made more money from long than from short with Cost Plus, too.
The authors criticized value investing as value investors tend to find cheap companies that are also poor in quality and these companies are often “dead companies walking”. But I think that the authors are mostly talking about cigar butt investors who focus on cheap valuations relative to the companies’ assets. Those cheap can well be “value trap,” a situation that value investors need to avoid. An important aspect of value investing is also about finding high quality growth companies that are sold at reasonable prices. This is where Warren Buffett (Trades, Portfolio) made most of his money. His successful investment like See’s Candy, Geico, American Experss (AXP, Financial) etc are growth companies and Buffett loved the growth of those companies. This is actually similar to what Scott Fearon practices in his own investing.
The authors also criticized “averaging down” in buying stock as in most cases the market is right and the stock prices are down for good reasons. But this should also be up to specific situations and whether the original research was wrong or the situation in the company changed. Sometimes the entire market decline can bring down the price of every stock. Also sometimes stock prices of small companies can crash due to market manipulations by, mostly, short sellers.
Like many value investors, Mr. Fearon missed the great investment opportunities in Starbucks (SBUX, Financial) and Costco (COST, Financial) because he was not willing to pay for the high valuations of the two companies. Good companies are rarely cheap, or cheap enough.
Mr. Fearson also exposed some misbehaviors which are common in the investing community but are popular in scamming average investors.
Overall this is a great book even for those who don’t short stocks. You will learn what kind of companies are “dead companies walking” or “value traps”, where value investors have lost a lot more money than paying too much for high quality companies.
I highly recommend it and have added it to GuruFocus list of recommended readings.
