What you don’t buy is just as important as what you do.
“We love to work at nothing all day.” – BTO
It was 5:34 pm on a Monday night. I was on the home stretch. The finish line was literally minutes away. I had spent the afternoon vetting a new company as a possible investment. Reviewing the minutiae at the back of this company’s most recent quarterly report was the last item on my checklist and I was on page 35. I had already gone over the financial statements, read through the transcripts of several conference calls, scanned the latest news releases, visited the company’s website, gone through the numbers with a fine-toothed comb, built my financial models, filled out my spreadsheets. I had done more legwork than usual on this one. It was a recent IPO so to get as complete a picture as possible of the company’s past history, I had to go searching through the EDGAR database to find the prospectus. That didn’t have the financial data I wanted so another trip back to EDGAR finally unearthed the numbers I was searching for in something called a “draft registration statement”. All this sleuthing takes time.
I had started my journey shortly after lunch, so at this point I was about 5 hours into the process. Things were looking good. I was reviewing a distributor of eco-friendly packaging for the restaurant industry. With the rise of the food delivery industry these guys had been on a roll. Sales were on a tear, earnings were strong, gross margins were up. The p:e ratio was, of course, low. (I wouldn’t be looking at it otherwise.) There were a few nagging concerns but there always are. Nothing I couldn’t live with.
I had dotted all the i’s and crossed all the t’s. Almost. There was just this one last item on my checklist. I was laboriously working my way through the “notes to financial statements” at the back of the most recent quarterly report. It can be a chore to stay focused and alert through these things. There’s a lot of fine print to struggle your way through. It’s like actually reading and paying attention to those long lists of terms and conditions when you sign up for something. Everyone knows no one actually reads those things. The notes to financial statements are like the terms and conditions of buying a stock and I actually do read them. Anyways, I was on the very last item in the notes. I had already mentally given this stock the green light. It had taken all my tests and passed. I had started planning what I was going to make for dinner (spinach mushroom risotto). And then, on the last bloody page of the last bloody report I was going to look at, I found this little gem…
“In connection with the preparation of this Quarterly Report on Form 10-Q, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of September 30, 2022. Based on this evaluation, management concluded that certain material weaknesses in our internal control over financial reporting identified in our Annual Report on Form 10-K for the year ended December 31, 2021 were under ongoing remediation and therefore continued to exist, and as such, our disclosure controls and procedures were not effective as of September 30, 2022 for the following reasons: … Management did not maintain appropriately designed entity-level controls impacting the control environment and risk assessment procedures to prevent or detect material misstatements to the consolidated financial statements.”
And just like that, 5 hours of work down the drain. Being able to say “No” is a huge part of what I do. Most low-priced stocks are priced low for a very good reason. But that reason isn’t always obvious. It requires some digging to unearth. Sometimes a lot of digging. It is not uncommon to spend hours working though a company, getting intimate with its details, building up a picture in your head, only to have all your hard work come crashing down around you with one obscure paragraph buried deep in the fine print of a financial filing. Or one off-hand comment in a conference call, or one line item on the income statement from 5 years ago.
It is punishing to put in hours of blood, sweat and tears into reviewing a company only to throw it all away. You spend time building the case for an investment. It’s a long process of convincing yourself that the stock is worthy of your hard-earned dollars. By the end of it, you find yourself psychologically invested in the story. And then some obscure line item can shift everything 180 degrees and you have to have the mental flexibility and fortitude to turn your back on all that invested effort and say, “No, I’ve changed my mind, this thing that I thought was a great investment, that I spent the last few hours convincing myself to buy, actually belongs on the dogpile”. Next.
I’m putting the finishing touches on a review of third quarter results. Start to finish it’s taken me about 2 weeks but those are 2 fairly intensive weeks. I work long days, I work weekends (As much as possible. My daughter dragged me to the mall this past weekend to try on T-shirts so she could pick one to give to her boyfriend for Christmas.). I often find it difficult to sleep; my mind is racing with numbers and scenarios. Sometimes I’ll find myself pecking away at the keyboard at 3 am. Like I’m doing right now.
And for the second quarter in a row, I’m coming up empty handed. I’ve said “No” many times over the past 2 weeks, often after putting in hours researching a prospective company. Walking away never gets any easier but you have to say no a lot of times to get to yes.
I wish I could remember where I read this, but it is an image that has stuck with me. It is a story about a young man, an apprentice carpenter who notices that many of the older craftsmen have missing fingers or horrendous scars from working with the heavy machinery day in and day out. But one particularly venerable workman has pristine hands. The young apprentice asks him what his secret is and he says that every day, before he starts work, he stares at his hands. He looks closely at every line and wrinkle, he wiggles all his fingers and he takes the time to be mindful and appreciative of his hands and what they mean to him. And then he turns on the power saw and gets to work.
I think investing is kind of like that. At the end of a long day, it is easy to let your eyes glaze over as you plow through yet another page of financial fine print. But you have to stay vigilant. Even if you think you’re on to a sure thing. Especially if you think you’re on to a sure thing. If you let your mind wander, if you let your guard down, if you put in a half-assed effort it won’t be your fingers that you lose, but it might be the $10K or $100K that you were going to put on the line.
I’m proud of the track record I’ve built in the stock market over the years. But I’m equally proud of my longevity. I’ve been at this game for 26 years now and full time, actually earning an income and supporting my family with my stock market investments for 19 years.
They say investing is a young man’s game. It takes a certain amount of reckless bravado, naïveté and brash, self-confidence to get into this game. (There’s a reason why the majority of my readers are male.) But many of those players don’t make it. The survivors are those that can walk a fine line between reckless optimism and cautious prudence. You need to be able to hope for the best and plan for the worst. Always keep an eye on the exit. And get ready to say “No”. A lot.