Dead Companies Walking — Book Review
I review books that I feel have added value to me. A detailed list is available here — https://twitter.com/marginalideas/status/1089519194062737408?s=20
Dead Companies Walking
This is about understanding when a company is sliding towards bankruptcy, regardless of the stock price.
Also, how to short it. It also helped me understand when to start selling, which has been a big issue with me.
One of the most important assertions of the author is that “Things go wrong more often than they go right”. Failure is the common outcome of any business venture and this doesn’t necessarily have to be frauds. Good, smart people fail. And one of the key reasons is they fail to see changes coming and are in love with their own ideas
Most of the companies that fail are just plain old failures, the result of bad ideas, bad management or a combination of the two. Some of the common mistakes of management are:
a. They learned only from recent past (History is not 20–30 years, but more than century or sometimes even longer — Historical Myopia)
b. They relied too heavily on formula for success (Not everything is a formula)
c. They misread on alienated their customers (What a customer needs can be and is usually, very different from what you need)
d. They fell victim to a mania
e. They failed to adapt to a tectonic shift in their industries
f. They were physically or emotionally removed from their companies’ operations.
Historical Myopia is very common in commodities industries where management tend to look at what they have experienced and forget the longer, super cycles. This has led to many a failures in banking and oil industries. Management tend to draw conclusions only from recent past instead of overall history and that is a deadly mistake. People just don’t look far back enough.
Another issue with value investors (including myself) is that we get so drunk on cash flow figures that many of us missed a sobering reality — Company’s growth is as important. This has led many mistakes of omissions (HDFC, Asian Paints) and commissions (Value traps –Polyplex, Coal India). Get into what the future holds given the business scenarios, not just the historical cash flows.
Two of the best indicators of problems are — Rapidly shrinking revenues and quickly rising debts. Another issue is — Management is usually optimistic about their prospects — That’s their job! How else will they survive at the top? Usually, they allow their optimism to blind them to the reality of their troubles.
Another key issue is the doctrine of elite infallibility. Stanford’s dean was overseeing audit at Enron and it meant nothing in the end. Just because most of the management and analysts come from elite colleges doesn’t mean the cannot be wrong. This is exactly the reason they are wrong!
Most of us rely on some or other formula for stock picking. The key skill lies in when to overlook them. A great attribute of any business is whether customer care how much they pay — For eg. Starbucks . Customers usually don’t even remember how much they paid for that latte! A great business.
Another issue with most of the management is their eagerness to grow at hyper-speed. This almost always lands up in horrible performance and lead to fast death of companies which otherwise might have been successful. Given how “Growth” is the in thing today, this is going to be poison for companies world-over.
More often that not, stocks of companies keep trading even when businesses have failed long way back. It’s more aggression and hope than irrationality. These are good short candidates — PCJ, Jet Airways.
Another type of failures discussed in detail here is when the management starts believing that their customers want the same thing as them. The author did the same mistake with his restaurant. JC Penny CEO thought people want expensive stuff and like. The CEO wanted to transform JCP into a luxury business because that’s what he and his friends wanted and he assumed others want the same. He basically fired his own customers!
I see a lot of same mistake being done by a lot of privileged Indian founders opening new companies selling things they believe is normal. They are not.
Understand your customer first and your friend circle is not your customer.
Another thing that is discussed in detail is the kind of people in business and finance. They are highly competitive and have an obsession with winning at all costs. And that is a very destructive quality. It’s actually the last thing you should want in someone handling your money. Why? Because quitting is very important when you’re buying and selling stocks. Or when you are running a business as well.
The fact that more companies fail than succeed means, as an investor, you’re going to have to deal with losing investments. Excessively competitive people have a hard time accepting this reality. They overestimate their own abilities and their own chances of success.
Worst of all, they are reluctant to give up when things turn bad. That’s the real danger of competitiveness. Remember the old saying: “It’s okay to be wrong; it’s not okay to stay wrong.” Too often, investors break this rule. They think they can will their stocks to victory somehow, that things will come out well in the end if they just try hard enough.
And that’s just not how it works.
Businesspeople make the mistake of thinking they can will their ventures to success as well, but in a slightly different way. Rather than getting too emotionally attached to their creations — they take a more cerebral, but no less flawed, approach. Most entrepreneurs and corporate executives are, understandably, confident people. They have an unshakable faith in their instincts, their intelligence, and the products or services their companies offer. But, over the this self-assurance blind even the sharpest, most capable managers to a fatal problem: their target customers simply don’t want what they’re selling.
I can think of so many of such kind of businesses, cropping up every day.
Lots and lots of very smart people make this mistake. They fixate on some given set of data or analysis instead of the most important data set of all: how people in the real world behave. You can know everything there is to know about your industry — market trends, leading indicators, the latest technology — but if you don’t know your own customers, you might as well be trying to sell gumbo to gray-haired flower children.
A sidenote — A good intro on why Webvan, the original retail online grocery raised $800 mn and failed. There’s an HBS case study from 2003 on this. People betting on online grocery today (Everyone?) would do well to study this!
Another interesting thing — Manias don’t die easily, especially when they’re fueled by rich, powerful, and obsessive people.
Best idea is to stay away from manias — Don’t go long or short in them. Just avoid.
One of the best question to ask a management is — What are the reasons their business will fail? And run away from those who think there is no way they can fail. That is a very dangerous mind-set, because believing that you can’t fail is one of the best ways to do just that.
Management needs to have faith in what they are doing, but an important skill is to separate Blind faith from faith. Nowhere has it been more true than Pharma and BioTech (And E-mobility now?). Passion is good. Learn to separate it from blind passion. Run away from maniacs!
There’s no one method or approach that makes for a successful investor. But there is one common trait that the author (and myself) believe all great investors share: intellectual curiosity. Good money managers are broad-minded and intellectually curious. They don’t, no, they can’t just accept conventional wisdom. They are vociferous readers. They crave new ideas and when they hear them, they’re willing to try them out. They’re not afraid of something just because it’s novel or disruptive. In fact, the more iconoclastic an idea is, the more curious they are about it.
Unfortunately, this attitude is exceedingly rare on Wall Street.
And Dalal street.
Misguided attempts to preserve an outmoded business model are quite common, and not just at dead companies walking. Starting in the late 2000s, cable television providers began steadily losing subscribers as more and more young consumers in particular “cut the cord” and watched their entertainment online. Big Cable managed to maintain its margins by raising prices. But charging a shrinking pool of customers more for the same product is probably not a sustainable long-term model.
Blockbuster, Kodak, Nokia are big examples of these.
Management fail to see their industry has fundamentally changed. One reason for this is that most of the management live in a cocoon and fail to see reality.
Be aware of managements who live in a different city, move around with different crowds than their customers.
Use common sense — Which managements tend to forego. During pager and cellular phone times, many a pager companies’ managers felt that people will carry both pager and a cell phone — Hilarious as it may sound. Businesspeople who fail to see changes in their business, fail.
Always looks at corporate spending. A very lavish office for a company whose fortunes are dwindling very fast is bad indicator (Yes bank?).
Many examples here. Does the management overspend, travel business when the business is in dumps? Best idea is to dump the stock then.
Another cause of worry if management blaming macro/external factors for their woes instead of taking the blame and correcting it. They themselves believe these stories and this makes recovery impossible. Perpetual weather excuse for apparel companies is a classic case.
There are few Indian companies which come to mind for this. They are good short candidates. And run away from these managements. Most of the time issues are internal and only those who accept it, can correct it.
Side note — short-sellers are almost always the smartest, the most savvy, and also the most cautious investors out there. If they weren’t, they’d all be broke. And contrary to popular opinion, they don’t target companies based on malice, and they don’t delight in the near ubiquity of failure in the business world. They simply acknowledge how common failure is and invest accordingly.
I have experienced this first hand when I started shorting 3 years back. It requires much more effort and is generally, more rewarding.
The theme that I like the most is — Get up and go outside, You’ll learn more in five minutes of talking to someone at a company than you will in a week crunching its numbers. This one thing will save a lot of investors from frauds and usual failures alike.
My own experiences with scuttlebutt has been amazing and helped me pick good companies (VIP?) and avoid potential failures (Yes Bank?)
Most executives are very smart people. But very few leaders, despite their intelligence, are willing to face hard facts and revise their thinking. That’s one of the main reasons more businesses fail than succeed. The same thing is true in money management. You don’t wind up running hundreds of millions or even billions of dollars of other peoples’ money without being intelligent.
But intelligence doesn’t guarantee success. See the attached picture.
So yeah, overall great one on understanding patterns of failure amongst management and how to spot the same. A must read for all investors, more so for the Indian ones.
Happy to discuss more.