August 28, 1998

Using the Trouble
by Rick Aristotle Munarriz (TMF Edible)

Yeah, that's right, Louis Corrigan and I are Troublemakers. Along with the unheralded editorial and production heroes that breathe life into this feature, we are fiscal forensic scientists, digging up some pretty gruesome stock stories all in the name of looking for Trouble. As we walk through the ruins, the lesson gets louder and louder each time: History repeats itself. History repeats itself.

That is what we aspire to do with the Daily Trouble as we profile companies whose stock prices have been cut in half over the past twelve months. The more time one devotes to the post mortem the better prepared an investor will be in recognizing the symptoms. This is not a perfect science. Sometimes the market is truly efficient and the debacle comes hard, fast, and unexpected.

However, way too many times you can see telltale signs of deficiency. Inventory or Accounts Receivables may build up at a company and serve as warning signs only to those who take the time to scour the filed financials. Coattails can get bloodied too -- when there is fundamental weakness for a competitor, supplier, or client, those events can often trickle down to the eventual tumbler. Insider selling is a natural occurrence, but when it is too many shares sold by too many insiders with no granted stock options to coincide with the equity exodus -- be wary. (Be Foolish!)

The lead time between cause and effect can be as short as immediate, as long as months. The former hurts; the latter is gratifyingly avoidable. From the outside, watching these whodunits in reverse, we start at the climax then retroactively look for clues. A company reports an earnings shortfall or pre-announces the shortcoming, and as the stock falls, Louis and I hit the rewind button.

Unfortunately, sometimes there are no flares to signal the danger. Perfectly healthy companies secretly wither away on the inside. Unless it's a compelling story or the future prospects seem to be misunderstood by the market, I simply don a dark coat, give a somber tip of my hat, and walk out on the eulogy.

The best candidates for Trouble are those fire alarms that gave Foolish investors time to collect their belongings and calmly exit the stock before it burned down. For example, an overambitious and unnecessary secondary stock offering -- done simply because the share price was attractive. Or executives leaving the company -- in droves. These disasters in waiting may sound obvious, but the reality is that you wouldn't believe the elasticity of the rubber band that ties cause to effect.

Remember the recent Asian flu? Gesundheit! On the back of that very Kleenex you could have jotted down the logical losers (major exporters to Asia) and winners (major importers from Asia). But investors waited for the respective companies to publicly announce the earnings shortfall. The long line of exporters and companies with significant Asian interests, all waiting to mount the platform and be fitted for a noose, was there to be had. Cause. Effect. Carnage. That's a perfect story for a Troublemaker like me.

The other aspect that draws me to a company is when the stock seems to be mispriced in the aftermath. Sometimes the share drop is overdone, other times it is not done enough. Ugly as they are, we sometimes get attracted to these sewer stocks. There can be an asset-rich balance sheet that is being ignored. The weakness may very well be a short-term contained event. Some Troubles are Doubles just waiting to happen.

On the other hand, even after serious tumble, some hype-heavy stocks may need some more deflating before they approach any kind of reasonable level.

The one common thread that binds the model Trouble is opportunity. If there was an opportunity to get out, great. If there is an opportunity today, long or short, better. By dissecting historical lessons and pointing out the urgency of personal due diligence, I think the knowledge that the feature imparts is significant. Not thanks to me -- I'm just that morbid mortician, drawing lots with Louis to see whose turn it is to poke sticks at lifeless equities to see if anything moves. No. Thanks to the debacle purveyors, for giving us a rich textbook to learn from again and again... and again.

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