Scumbaggery matters, but only up to a point

When researching a stock, sometimes I stop caring about how shady the insiders might be.  The quality of a business usually overpowers insiders’ shadiness.  For example, Steve Madden (SHOO) is an example of terrible corporate governance.  It originally began as a ‘chop stock’ (similar in concept to a pump and dump).  Many of the people behind the scam went to jail or were barred from the securities industry.  Steven Madden, the founder of the company, went to jail.  But even after many people went to jail, the shenanigans continued.  While in jail, Steve Madden was paid a high six-figure salary even though he admits that he didn’t work while in jailDespite all of this… the stock did incredibly well since its IPO.  In many cases, the underlying business can make far more money than insiders end up stealing/siphoning/wasting.

What I’m really trying to look for are the situations where the underlying business is terrible and insiders don’t care.  If management is part of a pump and dump scam, their compensation depends heavily on the success of the pump and dump scam and not so much on the success of the underlying business.  This can create crazy situations where management will willingly waste money to keep a stock promotion going.  This is what generally happens in the junior mining industry- many of the management teams don’t care if the company’s projects have a negative expected return.  But occasionally the bad actors coincidentally happen to be sitting on top of good assets, like a brilliant shoe retailer or a diamond exploration company that happens to find a nickel deposit without any diamonds in it.  When a stock has bad actors combined with good assets, I generally don’t bother because the risk/reward may not be favorable.

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