I'm a big believer that one of the keys to being successful in life no matter the pursuit is to read a lot. It keeps the mind sharp and, above all, it's an enjoyable pursuit, particularly if you can figure out what you most enjoy reading. For me it's two primary topics: anything investing-related and anything U.S. presidents-related.
The book I'm currently wrapping up is a doozy: The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron by Bethany McLean and Peter Elkind. From an investor's perspective it's really interesting stuff, and it's a pretty incredible story about business, hubris, deception, and greed.
Of course, the Enron story should be fresh enough on most minds still, but for investors there are plenty of valuable lessons from the calamity that are always worth reiterating and examining. So yesterday I started brainstorming and here are some of my key takeaways thus far. Some are pretty obvious, others maybe not as much. But for investors of any level I think they're points worth remembering:
- If it sounds too good to be true, it probably is.
- There is a difference between confident management and straight-up hubris. The former can do wonders; the latter can be extremely dangerous.
- Anytime management is focused on running the business to boost the stock price, it's a pretty safe bet they are making decisions based more on the short run versus setting the business up for long-term success.
- It's not a good sign to see a business branching out into businesses that don't make any sense and that aren't in line with the core business and what it's supposed to do well.
- The more difficult a company's financials become to understand and digest (income statement, balance sheet, cash flow statement), the more aware you need to be that there can be potential ticking time bombs hiding in them.
- Beware of the levered balance sheet. Debt is one thing; exorbitant debt is another. Particularly if sales aren't keeping up. If a company has a lot of debt, look deeper into the terms, ratings, due dates, rates, etc. Also, looking at the coverage ratio (operating income divided by interest expense) can be very helpful in understanding whether the company can actually afford that debt. Lower is worse.
- When all of the analysts covering the stock are all fawning over the business, start looking for the contrary indicators. Don't be contrarian for contrariness's sake, but don't be scared to call out a red flag or two. Try to find what others may be missing.
- Beware of management that spends lavishly on the business. Are they spending frivolously? Using the company as their own piggy bank to live a life of luxury?
- Management is not a thesis. Great management is a quality that can make for a good investment but it doesn't make it a good investment on its own.
- What kind of company and CEO ratings do you think Enron would have garnered on Glassdoor? Methinks they would have probably been pretty good. The point is to take ratings like these with a grain of salt; they are not the bottom line either way.
- Remember that no matter what the company or the story is, as investors we are taking a measure of a leap of faith every single time and there are never any guarantees.
- No matter how regulated a business is (governments, SEC, etc.) the regulators can miss it too, by choice or otherwise. Highly regulated doesn't always mean lower risk and money can make people do crazy things.
- The more convoluted the ownership structure, the more opportunity there is for management to pull the wool over your eyes. Beware the 10-K loaded with footnotes.
The Foolish bottom line
I'm sure this is just the tip of the iceberg and there will be more. But the point of this exercise is to reiterate the lessons that we can learn from what we read. If you take the time to jot down a few ideas and takeaways, you'll be the better for it. If you've read the book please feel free to add your thoughts in the comments and as always, hit me with any questions!