“Know what you own and know why you own it.” – Peter Lynch
When it comes to investment, even the greatest of them all makes mistakes. The Oracle of Omaha himself once lost up to $3.5 billion purchasing Dexter Shoe Co. which was 1.6% of Berkshire Hathaway’s net worth at that period of time. An investor who makes no mistake has very likely not invested himself.
Making mistakes is just part of every investors’ learning curve. Value investors generally buy great companies and tends to hold them for the long term, if not forever. Then comes the next question, what if we fall into investing in fraudulent companies?
Enron Corporation’s bankruptcy in December 2001 was a good example that shook Wall Street to its core. The Wall Street darling once reached great heights selling at $90.75 per share, only to suffer an outrageous fall overnight, selling at $0.26 per share. Thousands of investors and employees were affected by the massive collapse. Till today, many wonders how such enormous business, known to be one of the largest companies in the U.S, disintegrate almost overnight, fooling regulators and investors with fake holdings and off-the-books accounting for so long.
This is the consequence of investing without the right analysis. Inexperience investors often overlook the fact that the stock market consist of exceptional companies as well as poorly managed companies. Those who fail to see the truth may potentially fall victim to this kind of trickery. So, how do you avoid falling into this trap? If you are unsure, here is one solution for you, Scuttlebutt Investing!
What is Scuttlebutt?
The term ‘Scuttlebutt’ generally refers to rumours or gossip. The origin of the term is related to sailing. Water on sailing ships was typically stored in a scuttled butt for consumption – a butt (cask) which had been scuttled by making a hole in it so the water could be withdrawn. The definition of the terms comes about since sailors exchange gossip when they gathered at the scuttled butt for a drink of water. Scuttlebutt became slang for gossip and rumors. It is not difference from the more modern office equivalent – “watercooler talk”.
As to relates to investing, the practice of scuttlebutt is the homage of Phil Fisher which you could find in his book “Common Stocks and Uncommon Profits”. The practice is referred to conducting due diligence about a company and its investment grade by talking to various of people related to the product/services such as; customers, vendors, trade associations, competitors, former employees, and current employees. This is a qualitative assessment on the ground level. This practice is of course way above and beyond all the analysis of financial statement and standard due diligence that a normal investor would expect to do.
Why is Scuttlebutt research Important?
There are two main key reasons why scuttlebutt research is important?
1) It provides in-dept insights into a company that can’t often be had through by just reading. By talking to the former employees and current employees of the company can provide valuable insights about employee morale and sentiment. By asking the current and former customers can also be an extremely valuable source to know whether the products/services are of quality which leads to assessing to company’s moat and potential switching cost.
2) It is the first layer of primary research as compared to the secondary research of analyzing the financial statements. Primary research is essential because you get to see the product/services used by the mass market on a daily basis and it helps investor to build their conviction and confidence when market is selling off indiscriminately. The primary research and due diligence provide strong conviction that cannot be obtain from secondary research alone.
Let’s move on to the methods of practicing scuttlebutt.
Practice Invert Thinking
Look for disproving information because by conducting many researches could lead to some level of confirmation biasness due to the amount of time vested on researching a company. It is important to do the opposite which prompt investors to look for and analyze information that disprove your initial researched. Talk to people on the other side of your biasness that does not view the company as favorably and understand what and why they say, does it make sense or doesn’t make sense. Make a comparison on all the collected facts between the good and bad.
For example; recently the Ringgit has strengthened against the US dollar for the past few weeks just by a few cents. The market was in panic mode and investors start to indiscriminately dump their shares in one of the glove company but have forgotten that this foreign exchange issue has happened before few years ago which does not affect much of the company’s profit. Behind chaotic market, the founder of the company has been buying more shares in the open market even thou he has owned a majority stake in the company.
Getting Out of the Box
Talking to everyone and get out of the echo chamber that is your mind. Humans have a tendency to stick together where humans of a same status gather together. We self-select our friends and make friends that think like us, share our opinions and act like us. From the investing perspective, this require the investors to get out from their comfort zone and talk to a diversity of people before reaching on a point of view.
For example; you are interested to invest in the garment industry, hang around in the mall during peak hours and observe what are the brands does the mass market consume. Another way is while you are taking Grab (E-hailing app), you may ask the driver which brand of garment do you prefer? To your surprise, you might gain some interesting findings.
Put Yourself in the Shoes of the End Customer or Consumer
By empathizing with the end customer or consumer through finding users of the products and services and understand why they use it and what they like about it. Consumer’s experiential experience set the tone between a similar product/services which translates to a broader picture on the brand and pricing power of the company that manufacture or provide the product/services.
For instance, in the market people have been asking ‘Has Apple lost its Appeal?’. In the western country, Apple users are locked into the Apple’s ecosystem and comfortably using it on a daily basis, one of the examples are; Apple users have been using Apple Pay to pay for their daily products. On the other end of the world in the asian continent, Apple products are view as luxury items. To some extent, people would buy Apple’s iPhones to propose in their marriage proposal. This shows that Apple has successfully build a brand with pricing power to its high perceived value of Apple’s products.
The objective of practicing scuttlebutt is not to get inside information. It is to get the context and color that you wouldn’t otherwise get from reading. These first layers of primary research set apart between the successful investors and the mediocre investor. There were many proven successful investors such as Warren Buffett, Peter Lynch, Benjamin Graham, and Philip Fisher whom did more than just analyzing numbers. They went on the ground to speak with the company’s CEO, board of directors, managers just to evaluate the business model and capability of the management. By touching the brick, these successfully investors would invest a big sum of fund into the company and hold for long term.