Dead Companies Walking: A Book Review

Scott Fearon is the founder and president of the Long/Short hedge fund Crown Capital Management. He’s also the author of one of my favorite investing books, Dead Companies Walking

The book chronicles Fearon’s three-decade excursion through markets as he relives wins, losses, and lessons learned from finding opportunities in unexpected places. 

Specifically, Fearon’s book explains how to think critically about investment ideas, company business models, and industry trends. All through the lens of the one thing that matters most: the individual consumer

Fearon’s greatest skill is his ability to leverage the consumer mindset to understand the 1-3 things that drive any investment outcome. The best part is that he uses actual examples from his investment career. 

This review combines lessons learned from each chapter, examples from the book, and personal commentary on how I apply such lessons in my investing journey. 

Let’s get after it. 

Long Human Connection, Short Formulas (Chapters 1 & 2)

Geoff Raymond taught Fearon the basics of investing. Fearon met Raymond during his time at Texas Commerce Bank in Houston. 

One of the first things Fearon realized about Raymond was his patience (emphasis mine): 

“When it came to picking stocks, Geoff was never in a hurry. He was very deliberate. And he believed in something extremely unusual in those days – actual research.” 

We live in a world that gets off to more and faster information. We mindlessly refresh Twitter hoping one of our favorite follows posts something positive about our stocks.

Yet the best investors I know practice the opposite approach. They’re constantly searching for ways to remove information sources, reduce the noise, and methodically focus on what matters most, actual research

Allan Mecham is an excellent example of “not being in a hurry.” Mecham did less than most investors yet generated far superior results than 99% of his competitors. 

Mecham explained the benefits of doing less in an investor letter (emphasis mine): 

The steady surge of information coupled with short-term performance pressures can push rational long-term investing to the brink of extinction. The easy access to information, and the snack-bar nature of consuming it, suggests that disciplining one’s temperament rivals the need for energy and action.”

This begs the question … What types of information should we spend our time? If more isn’t always better, what is? Raymond’s answer is about as old school as it gets. Back to the book (emphasis added): 

“[Raymond] believed that human-to-human contact was the best way to gauge a company’s future performance. He valued numbers and raw data, but he knew that numbers were easy to fudge or mis-read. You had to study the people behind the numbers to get the full story.” 

Number-crunchers hate this quote. They can’t screen for great “human-to-human contact” like they can Gross Margin % or FCF/share growth. 

As Fearon explains in the following paragraph, “You had to go see them where they lived and worked – their own offices.” 

Financial formulas are a commoditized product if the human connection is an investing edge. Fearon reveals the dangers of formulas using the company Global Marine as an example. Back to the book (emphasis added): 

“Buying stock in Global Marine at 70% utilization was what they call, in sports betting, a ‘lock.’ That’s why he was so relaxed and confident when Raymond and I met him.”

According to Fearon, the Global Marine executive hyper-focused on one formula: utilization rate. The oil man couldn’t hide his excitement around this “magic” 70% figure (back to the book, emphasis mine): 

“Right now, we’re just below 70% utilization. And that means one thing as far as you guys are concerned: buy, buy, and buy some more. I’ve been in this business for decades, and 70% is always the bottom. It never fails.” 

Formulas provide investors with a shorthand version of finding potential investment ideas. But they also create massive opportunity cost gaps. Fearon’s familiar with such opportunity costs in two small Seattle-based companies: Costco (COST) and Starbucks (SBUX). 

Here are Fearon’s comments on how he missed COST and SBUX thanks to formulas (emphasis added): 

“There was no doubt in my mind that both of these companies [SBUX and COST] were going to prosper. My gut was telling me to jump in and buy thousands of shares of each. But my head just wouldn’t let me. In the end, I talked myself out of investing — and that wound up being an expensive conversation.”  

It’s easy to judge Fearon with the benefit of hindsight bias. But few card-carrying value investors would’ve pulled the trigger on both companies. COST and SBUX traded over 30x earnings during Fearon’s initial meeting with management, and he explains his rationale for not buying (emphasis added): 

“By the GARP (Growth at a Reasonable Price) formula, COST’s past and projected earnings were not enough to make the investment worthwhile. Its earnings multiple was quite high, in the thirties. The idea of investing in a company with those kinds of numbers was a big stretch for me, no matter how promising it seemed. I got the same result when I crunched the numbers for Starbucks. Its P/E was also well over thirty.” 

COST and SBUX are great examples of the double-edged nature of financial formulas. Sure, they help you avoid disasters. But they also miss once-in-a-lifetime companies.

Consumer Rationality & Fact-Checking Manias (Chapter 3 & 4)

As I mentioned before, Fearon has a world-class ability to use common sense consumer logic to identify strengths and weaknesses in any product or service. He provides examples of such insights in Chapter 3, starting with JCPenny’s collapse in 2012, which is where we pick up in the book (emphasis added): 

“In 2012, JCPenny’s management team famously ‘fired its customers’ by eliminating coupons and stocking more expensive brand-name merchandise. The problem was that the people who shopped at JCPenny liked using coupons. They enjoyed the feeling that they had discovered bargains, even on no-name or knock off brands … These disastrous changes wound up losing the company more than a billion dollars in a single year.” 

JCP made such changes because executives wanted JCP stores to feel like the luxury shops they routinely visited. JCP missed that the luxury model would’ve never worked, given the company’s store geographies and demographics. 

Watch how Fearon uses consumer logic to reach the heart of JCP’s strategic shortfall (emphasis added): 

“JCPenny was never going to transform itself into a luxury brand like Apple or Saks or Lexus. Most of its thousand-plus locations are in middle-and-working class areas, and nearly 100 of them are in its home state of Texas.” 

Fearon only needed two pieces of information to recognize JCP’s downfall: 

  1. JCP customers loved bargains, and it was one of the core reasons they shopped at JCP
  2. Most JCP stores were in middle-to-lower class areas where luxury shopping wouldn’t work well

Another example of leveraging consumer common sense to investment ideas is Fearon’s story of First Team Sports (ticker symbol: FTSP at the time). 

FTSP was a leading inline skates manufacturer (i.e., rollerblades). And at one point, rollerblades were the must-have item in the country. Think Silly Bandz-level excitement. 

Anyways, FTSP sold this must-have item, and the stock looked fantastic. Every metric rocketed up and to the right. Fearon wanted to know if this fad had legs, which is where we pick up in the book (emphasis mine): 

“I did call an analyst handling the stock a couple of days later. I asked her, ‘Is this Rollerblade thing for real, or is it going to go the way of the Slinky and the Hula Hoop?’ 

‘Oh no,’ the analyst answered breathlessly. ‘Rollerblades are here to stay. They’re huge and they’re only going to get more popular as time goes on.’

Fearon desired the reason behind the analyst’s conviction. So he prodded (emphasis added): 

“Let me ask you a question … Do you rollerblade?”

“‘Absolutely!’ she exclaimed. ‘So do all my friends. I do it every morning before work. It’s the best workout you can get!’”

This is my favorite part of the chapter … “I thanked her for her time, hung up the phone, and promptly shorted the stock of First Team Sports.” 

The analyst’s problem, of course, was confirmation bias. She rollerbladed. All her friends rollerbladed. Everyone she knew rollerbladed. She extrapolated her circle of friends to the entire universe to create a TAM for her favorite exercise equipment manufacturer. 

Fearon immediately identified the most essential issue with FTSP’s long thesis (emphasis added): 

“The average Wall Street analyst is three things: young, affluent, and hypercompetitive. In other words, people like that analyst I spoke with are the prime demographic for a fad fitness product like inline skates.”

Does anyone else think of Peloton (PTON) after reading that sentence?

Executive Antilogic & Digging Trenches Syndrome (Chapters 5 & 6) 

Management teams are incentivized to believe in their own cooking. To think that the ideas they create will save the company. Even if they produce shitty ideas. 

Blockbuster is an excellent example of (to steal from my friend @DoombergT) Executive “Antilogic” and Digging Trenches Syndrome. 

Today everyone knows that Netflix ate Blockbuster’s lunch. But why did NFLX succeed when Blockbuster suffered? Let’s head to the book where Fearon meets with Blockbuster’s Head of IR (emphasis added): 

“Despite this bad news [money-losing quarters, NFLX market share gains], Angelika was upbeat. She enthusiastically predicated a comeback for Blockbuster. I expected her to tell me that the company’s managers planned to accomplish this by expanding the online service they had launched to compete with Netflix. But, to my surprise, she said they were actually scaling back that effort.

We believe our greatest assets are our stores,’ she said.”

Instead of investing in the one thing that would’ve given them a chance against NFLX, Blockbuster doubled down. They dug deeper into what they knew: retail stores. 

Blockbuster’s Head of IR explained the company’s retail rationale (emphasis added): 

“We’re not just going to sell movies and video games. We plan to offer a whole host of ancillary products as well: movie posters, movie memorabilia, magazines and books about Hollywood. And at the point of purchase, all of our stores will feature theater-style concession items.” 

Reminds you of AMC selling popcorn, doesn’t it? We all know how the Blockbuster story ended. 

How about another, lesser-known example of the same concept: Page-Net (PAGE). 

Fearon remembered the time the CFO of PAGE pleaded his case for pagers despite the advent of the cell phone. We pick up in the book with Fearon asking a simple question: 

“Cellular technology is getting lighter and cheaper. Why won’t phone companies be able to expand into those markets at the same time as you?

The CFO replied, ‘We understand that many people will likely adopt cellular technology in the coming years. But we’re confident that consumers will continue to use pagers so that they can enjoy the added convenience of returning calls on their own time.’” 

Fearon then asked the most critical question, “Are you saying you expect people to carry both a pager and a cell phone?” 

We see an example of Fearon cutting to the heart of what matters most about a company’s future success: consumer adoption and logic. 

And again, we see one of my favorite lines in the book, “The next morning I shorted PAGE. Within two years, the company had gone to zero.” 

Executive Antilogic and Digging Trenches Syndrome permeate most management teams. Consider the words of the former Yellow Pages executive when Fearon asked about competition from Google and other search engines … “Our bread and butter will always be our traditional books.” 

Management says things like that when incentivized to maintain the status quo. Why? Because it’s cheaper, safer, and does not assign blame. 

Prioritize Mental Flexibility (Chapter 7 & 8)

Fearon showcased exceptional short-selling talent. But that didn’t stop him from changing his mind when the facts changed. I love this snippet from the beginning of Chapter 7 (emphasis added): 

The key is flexibility. I try not to have a rigid view of things. I assess the numbers, I meet with management teams, and I do my best to make the correct call on a given stock, whether that means shorting it, buying it, or holding off.” 

Cost Plus World Market (ticker symbol at the time: CPWM) is an excellent example of Fearon’s mental flexibility. 

CPWM is like Ollie’s Bargain Outlet (OLLI). You never know what you’ll find, but you always know you’ll get a great deal. CPWM IPO’d in the mid-1990s quickly shot to $44 or 67 trailing earnings. 

As Fearon noted, “I refused to join the herd given this sky-high valuation. But I continued to meet with management. That persistence wound up making me a lot of money, in unexpected ways.” 

Here’s how Fearon made his fortunes in CPWM. 

Fearon waited until the stock eventually traded to ~$18/share. By this time, the company had a new CFO and strategy. Fearon described CPWM’s updated approach (emphasis added): 

Cost Plus got caught up in the housing mania of the time and started stocking more high-end home furniture and fewer quirky knick-knacks. As a result, its stores didn’t have the same feel. The only way I can think to explain it is that they just weren’t all that much fun anymore.” 

We’ve seen this before with JCP’s attempt to bedazzle its brand. Unfortunately, it didn’t work for CPWM, either. Back to Fearon (emphasis added): 

“By my next visit in 2005, the company’s comps had turned negative and its stock was down to $20, half of where it had been two years earlier … I left that meeting determined to short Cost Plus if it dipped below $10. I pulled the trigger when CPWM hit $8. By February 2009, only twenty months later, the stock was down to $0.50.”

However, the strangest thing happened. Cost Plus actually turned things around. More importantly, Fearon maintained the mental flexibility to change his mind when the facts changed.  

CPWM hired a new CFO in September 2009. By that time, the stock traded at around $2/share. The new CFO took responsibility for the company’s failures and was already implementing a turnaround plan, which she explained the Fearon (emphasis added): 

“We’ve cut out high-end furniture altogether, and we’ve increased our emphasis on lower-priced gifts and consumables. Now we’re just hoping that our customers will continue to come back too.” 

Sometimes all it takes is management to pluck the low-hanging fruit of reversing its unforced errors. The results spoke for themselves. Back to the book (Fearon saying): 

“Cost Plus was already seeing an increase in the number of customers coming into its stores. Turns were going up, as well. To top it off, Jane [the CFO] showed me that, even after all its troubles, the company still had access to a large line of credit that it had arranged years ago and never exhausted.” 

More customers, higher turn ratios, and greater availability of capital. What’s not to love? 

Let’s make one thing clear. Cost Plus is the exception, not the rule. Most companies that drift away from their core strategy never return to profitability. They’re buried next to the Blockbusters of the world. 

What’s important to remember, and what Fearon stresses in these chapters, is that an investor must possess the mental flexibility to recognize when a legitimate turnaround is underway. Especially in a company that you’ve shorted. 

As Fearon says at the end of the book, “it’s okay to be wrong. But it’s never okay to stay wrong.” 

Concluding Thoughts: No Great Companies, Only Great Bets

Dead Companies Walking is one of those books I’ll probably read annually. I first read it last Thanksgiving. But at the time, its lessons weren’t practical. Remember, 10x EV/Sales was considered cheap the previous year. 

Fearon’s lessons hit differently in 2022. There are hundreds of dead companies walking. I won’t name names but look around. The businesses might not disappear, but the equity value can evaporate long before a company dissolves.  

This book isn’t a how-to guide on finding great short ideas. It’s a blueprint for finding great bets. And it might be the most valuable book you read this year.

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