A Review Of Scott Fearon’s “Dead Companies Walking”

The following review is straight from Operator Kean, a member of the Macro Ops Hub. To contact Kean, visit his website here.

Scott Fearon knows a thing or two about stocks —  especially when it comes to shorting them. His firm, Crown Capital, has averaged an 11.4% annual return since its inception in 1991. And fortunately for us, Fearon has shared his experience and insights through his book Dead Companies Walking: How A Hedge Fund Manager Finds Opportunity in Unexpected Places.

Here’s a few key insights from Fearon:

(I) “Frauds, Fads, & Failures”

According to investor David Rocker, the 3 types of businesses that go under are ‘frauds, fads and failures.’ As quoted by Fearon, “Most companies that enter bankruptcy fall into the third category. They’re just plain old failures, the result of bad ideas, bad management, or a combination of the two.

To detect failure the author looks for 6 common mistakes by business leaders:

  1. Only learning from the recent past
  2. Relying too heavily on a formula for success
  3. Misreading or alienating customers
  4. Falling victim to mania
  5. Failing to adapt to tectonic industry shifts
  6. Being physically or emotionally removed from company operations

(II) Be wary of ‘Elite Infallibility”

The author writes:

One of the primary causes of this unrealistic optimism in the corporate and investing worlds is an almost slavish faith in the capabilities of our country’s elite. People seem to think that a degree from a top university inoculates its holder from failure. I can’t tell you how many times stock analysts and fellow money managers have tried to convince me that a clearly troubled company would turn around simply because its CEO was a graduate of some distinguished school. “He’s Harvard MBA,” they’ll say in almost reverential tones, or, “He graduated cum laude from Princeton” – as if those facts alone would be enough to offset overwhelming evidence that, despite their impressive backgrounds, they were running their businesses straight into the ground… Whenever I hear this special pleading, I think of a guy named Robert Jaedicke. He was an accounting professor at Stanford when I was an undergraduate there. Shortly after I graduated, he became the dean of the business school. He parlayed that prestigious position into a number of lucrative seats on corporate boards, including the chairmanship of the audit committee for Enron. Jaedicke began that job in 1985, around the time I saw Ken Lay speak in the Transco Tower. Jaedicke held the job all the way until the company blew apart in 2001 in the biggest accounting scandal in American corporate history. In retrospect, it’s obvious that the only thing the board of Enron managed to audit in all that time was the buffet tables at their meetings. But right up to the end, the impression that such a distinguished figure from a top school like Stanford was overseeing the company’s books gave an awful lot of Enron investors a dangerously false sense of security.

(III) When betting against a ‘dead company walking’, it’s okay to be late

Shorting stocks is not for the faint-hearted. It takes a greater amount of skill to make money on the short side (especially if you’re betting on a company going to zero) than on the long side.

Because the market is long-biased (due to optimistic tendencies and a majority of long-only participants) shares of ‘junk companies’ can often stay afloat and ‘live well past their expiration dates.’ Short-sellers have to understand this reality and the opportunity costs and risks involved with it.

Short squeezes are also common and tend to shake short investors’ conviction and tolerance. As Fearon shared:

Sometimes it’s not irrationality that keeps the stocks of troubled companies afloat, it’s raw aggression. So-called momentum investors will seek out stocks at or near their 52-week highs that also have a good number of short investors. They’ll bid the price up even more, hoping to scare short-sellers into exiting their positions en masse, which serves to inflate the stock even further. It’s called a short squeeze, and it’s a brutal thing to live through when you’re on the receiving end. By waiting until a stock has already fallen more than half its peak value, I may sacrifice some potential gains, but I make more over the long run by avoiding these sorts of risks.

(IV) Wall Street’s inherent flaws – something to note

Fearon also makes a rather grim comment on Wall Street, whether you agree or not. He writes:

The financial world suffers from an inherent flaw: the people who work in it, by and large, are terrible investors.

Number one: They’ve spent their whole lives going along to get along. They’re climbers, strivers, joiners, cheerleaders. (That’s how they got those good degrees and those prestigious jobs in the first place!) This makes them naturally prone to groupthink and all too susceptible to manias and asset bubbles.

Number two: They are hypercompetitive, which keeps them from admitting failure and adjusting their strategies when things inevitably go wrong. This makes them all too susceptible to disastrous behaviors like averaging down and clinging to bad ideas.

Number three: They worship rich and powerful people, so they automatically defer to authority instead of questioning popular assumptions. Again, this makes them susceptible to manias and asset bubbles. It also creates an even more destructive mind-set – once they themselves rise to positions of power, they see themselves as infallible and worthy of worship.

Overall, the book is an insightful and easy read. It can refresh a veteran investor while at the same time pique the interest of an amateur. The book doesn’t cover the technical parts of the investment process, but it thoroughly explores the qualitative and psychological aspects of a stock picker that’s hunting for gems (or junk in this case).

To learn how the Macro Ops team uses shorting tactics in our own investment strategy, click here.

 

 

Dead Companies Walking

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Brandon Beylo

Value Investor

Brandon has been a professional investor focusing on value for over 13 years, spending his time in small to micro-cap companies, spin-offs, SPACs, and deep value liquidation situations. Over time, he’s developed a deeper understanding for what deep-value investing actually means, and refined his philosophy to include any business trading at a wild discount to what he thinks its worth in 3-5 years.

Brandon has a tenacious passion for investing, broad-based learning, and business. He previously worked for several leading investment firms before joining the team at Macro Ops. He lives by the famous Munger mantra of trying to get a little smarter each day.

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He started out in corporate economics for a Fortune 50 company before moving to a long/short equity investment firm.

With Macro Ops focused primarily on institutional clients, AK moved to servicing new investors just starting their journey. He takes the professional research and education produced at Macro Ops and breaks it down for beginners. The goal is to help clients find the best solution for their investing needs through effective education.

Tyler Kling

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He worked as a consultant to the family office’s in-house fund of funds in the areas of portfolio manager evaluation and capital allocation.

Certified in Quantitative Finance from the Fitch Learning Center in London, England where he studied under famous quants such as Paul Wilmott.

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Founder and head macro trader at Macro Ops. Alex joined the US Marine Corps on his 18th birthday just one month after the 9/11 terrorist attacks. He subsequently spent a decade in the military. Serving in various capacities from scout sniper to interrogator and counterintelligence specialist. Following his military service, he worked as a contract intelligence professional for a number of US agencies (from the DIA to FBI) with a focus on counterintelligence and terrorist financing. He also spent time consulting for a tech company that specialized in building analytic software for finance and intelligence analysis.

After leaving the field of intelligence he went to work at a global macro hedge fund. He’s been professionally involved in markets since 2005, has consulted with a number of the leading names in the hedge fund space, and now manages his own family office while running Macro Ops. He’s published over 300 white papers on complex financial and macroeconomic topics, writes regularly about investment/market trends, and frequently speaks at conferences on trading and investing.

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