The shortcut method for figuring out a company’s accounting

Here’s what I do… I look at how the company handles depreciation and amortization of its assets.  If management is trying to inflate earnings, it is highly likely that management will be aggressive in making aggressive estimated useful life assumptions behind D&A.

1. It’s really obvious to the accountants that they can inflate earnings by making more aggressive assumptions here.
2. Pulling this lever is perfectly legal since these assumptions are inherently uncertain and therefore subjective.  No one will go to jail for pulling on this lever.
3. All companies have to make assumptions on this accounting topic.

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Chart reading… the crazy short selling way (plus other silly tricks)

Here are some shortcuts that I use to quickly figure out a stock.

1. Mysterious price spikes on high volume and little/no news.  Sometimes, these coincide with stock promotion like an email blast, physical mailers arriving, etc. etc.  A stock that has many of these spikes is probably an egregious pump and dump.
2. The stock IPOed during the Dot-Com era and has been on a slow decline since.  Usually these Dot-Bomb wreckages are a decent place to look for shorts.  A lot of questionable stuff went public during the Dot-Com boom.  Such stocks have a tendency to stay somewhat questionable.  Pedigree matters.
3. The share price performance since inception isn’t very good.  Usually a sign of a bad or mediocre underlying business.

Short interest versus borrowing costs

In my experience, the cost to borrow shares is a far more powerful predictor than short interest.  Anybody who looks at short interest instead of the cost of borrow is probably not that savvy.

Save time generating ideas from Activist Shorts

Adam Kommel’s (and Wayne Gerard’s) company, aptly named Activist Shorts, is a research service that keeps tabs on free, publicly-available research put out by short sellers.  Some of this research is the best research available for a particular stock.  Some of these reports expose fraud and act as the catalyst for a stock going to zero.  Examples include Muddy Water’s work on Sino-Forest and Jon Carnes’ work on Fab Universal.  In those situations, I would say that these short sellers’ reports were the most important document that you could have read for that particular company- more important than the annual report.

There are two parts to Activist Shorts

1. The @ActivistShorts Twitter account, which is free.  I highly recommend following it.  I read it regularly to find out about all the latest reports being released.  You can read it for yourself on Twitter and quickly see whether it’s worth a follow.
2. A paid subscription service, which can save time if you spend a lot of time following activist shorts (I kind of don’t).

As commodity prices plunge, miners are stretching their numbers

My July 8 post “Mine economics explained” explains why I think capitalization of stripping expenses is bullshit.  The current trend is for miners to make more aggressive assumptions in that department to boost their earnings.  This is contrary to reality.  Lower commodity prices means that mines will close earlier.  It would make sense to take impairments on previously capitalized expenses.  (Or better yet, accounting rules should be overhauled to reduce accounting shenanigans, investor transparency should be improved, and the accounting burden on public companies should be reduced.  Simpler rules would benefit investors.  The problem is that the system has been co-opted by public companies that want to play games with their accounting and rulemakers who enjoy lucrative consulting gigs helping companies game the complex rules that they created.)

Drug reimbursement shenanigans

In the drug industry, there are different types of abusive practices that occur:

1. Drug companies encouraging off-label use (and/or “recreational” use) of their drugs, potentially harming patients’ health.
2. Drug companies encouraging doctors to increase dosages and drug use, potentially harming patients’ health.
3. Drug companies encouraging waste to increase the volume of drugs sold.
4. Pharmacy benefits managers (PBMs) selling out their clients (payors) in exchange for kickbacks from drug manufacturers.
5. Drug manufacturers using “specialty” pharmacies to bilk payors, tricking the payors into reimbursing expensive drugs that they would otherwise not reimburse.  Unlike traditional pharmacies, captive pharmacies can go the extra mile to obtain (possibly improper) drug reimbursement for the drug manufacturer.

This blog post will look at #4 and #5.

Throwing pennies in front of a steamroller

One of the annoying things about short selling is that frauds and stock promotes will occasionally be taken private, causing short sellers to lose money on their positions.  If a company announces a going private transaction or other takeover event, my opinion is that the best strategy is to cover your short position and redeploy that capital into other shorts.  Looking back at Chinese reverse mergers, it seems that almost every going private transaction closed.  There were a handful of non-binding going private transactions that didn’t close; those were the only ones worth betting against.