Phonies, Liars & Cheaters

From politicians, Major League Baseball players, to big name Wall Street money managers, it seems scandals have become so common place that the average person has become indifferent or apathetic to them.  Faith in some of the oldest and once revered American institutions seems to be at an all time low.

For those who do not follow MLB, Milwaukee Brewers star Ryan Braun was suspended earlier this week for PED’s (Performance Enhancing Drugs).  Just as baseball seemed to be getting clear of this cloud, there is now another wave of players set for similar punishments.  In Braun’s case, he has basically been caught in a lie.  Last season he was cleared after a technicality in the test, and then told a huge lie as he looked into the camera denying ever taking PED’s.

Anthony Weiner is still on the ballot for Mayor in NYC even after admitting that he was ‘sexting’ interns one year after he was initially caught and had to resign.  This phony leader is a shining example of what opponents of big government point to, entitled politicians who believe they are above the common person and are exempt from consequences of bad behavior.

Now in the most recent Wall Street scandal, famous, or now infamous, SAC founder and wealth manager Steven Cohen has been barred from the industry and may face criminal charges.  The SEC claims he failed to supervise two of his employees accused of insider trading, or cheating.  See the link below:

http://business.time.com/2013/07/19/u-s-regulators-file-charges-against-hedge-fund-billionaire-steve-cohen/

Recently, I have started to read Charlie Gasparino’s (FOX Business) new book, Circle of Friends.  Basically, the book has two parts.  Discussing the new push from the SEC in uncovering insider trading, and whether or not it is worth the expense to the taxpayers.  Secondly, he discusses the cozy relationship between SEC executives and high up Wall Street traders, and the premise that the average Joe or Jane really does not have a chance.

So what do liars, cheats, and phonies have to do with the common retail investor, as it seems the system is rigged? 

First, a point we have been banging on for three days now, is that a core/satellite investing approach is wise for a couple of reasons.  The core is not necessarily vulnerable to individual company scandals, as broad, passive index funds avoid this problem due to the number of holdings.  Also, the active investor/trader should follow his or her satellite portfolio rigorously, watching out for red flags like pending lawsuits and monitoring earnings reports.

There are a few metrics that are helpful that can be useful to take out foul play when stock picking.  First, following the smart money with heavy institutional ownership and favorable put/call ratios are two easy ones to consdier.  Second, a Price to Sales ratio is particularly applicable in our small cap world, as there is no manipulation of earnings at the top line.  While P/S does not give any indication of how well the company is run, it is an apples to apples comparison.  One additional P/S derivative that also helps is to use a Price/Forecast Sales (or sales at maturity) as a valuation method.  Finally, EV/EBITDA is a common metric used in evaluating takeover targets and also takes out any earnings manipulation.

I think for the most part, just like any other profession, investment professionals are honest and ethical people and a few bad apples can give the whole group the impression of rotting.  One other thing to consider when making stock picks from research reports from ‘professionals’ is to consider whether the source is independent or a large firm with research and investment banking.  Anyone can see the conflict of interest, which is supposedly blocked at major firms, with the two sides in one company.

Let’s hope the good guys keep their head up!

Have a great day.

Disclosure: Goldman Small Cap Research analysts are neither long nor short these shares but may elect to purchase the stock within the next 48 hours.

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