What are some of the reasons a company could fly under the radar? I have a few!
Hidden From Wall Street
Here are just a few reasons a stock might exist without a single look from Wall Street:
- No debt – Credit and equity analysts are swarming all over, but you’ll never get facetime with a credit or (eventually) equity analyst if your company runs on all cash. Businesses that are 100% equity financed do not draw the attention of financiers in the debt space, nor the equity analysts who might pick up an idea from the banking side. It is theorized that even Google issued debt just to get on analysts radar after the company had run without issuing a single security for years after IPO.
- LIFO accounting – Oh, boy, this is one of my favorites. One way to find a cheap company is to look at net-nets, those which trade for less than their net working capital. LIFO accounting has a tendency to reduce and understate the value of inventory, which means that many a cheap stock fly under the radar of screeners because these tools simply pick up the reported value of inventory, not the actual value of inventory.
- No public information – I like those hidden companies that other people haven’t analyzed, or which are too small that the media doesn’t cover. SeekingAlpha stands as a decent place to see just how many people are watching a stock. The site has publicly-available transcripts of conference calls for the most active stocks, which lowers the barrier to entry to analyze the company. (Protip: call investor relations; they’ll have transcripts.) Sometimes the only analysis is negative, like in the case of Metropolitan Health Networks which had some Looney Toon of an amateur post his own backwards forensic accounting findings. As wrong as he was, as the only person analyzing the company public in real time, he undoubtedly turned more than a few people away.
- Reported financials don’t matter – The numbers you see in a company’s financials don’t matter as numbers. These numbers are manipulated by information in the notes, the single most important part of any financial report. Without looking at the notes at the end of a quarterly or annual report, what you find in a company’s public data on sites like Yahoo Finance, Google Finance, or MSN Money are completely irrelevant. Reported numbers miss the screeners because the magic mix is in the notes.
- Analysts don’t trade their own accounts – My hunch is that most analysts do not trade their own accounts, likely because they’re too tired of Excel spreadsheets at the end of a long workday, or because HR compliance is a headache. So if analysts trained in the methods of analyzing companies only analyze companies that their firm finds investable, their talents and insights don’t extend into the universe of stocks that their firms don’t watch.
Work, what’s that?
Humans will be human. We don’t like to work for what we have. Why else would indexing be so popular?
The truth is, Wall Streeters are just like everyone else. Wall Street likes the easy ideas. When it comes to the public markets and one-upping Wall Street, it’s all about looking where others don’t want to look because it isn’t as easy or convenient.
Want to find undervalued stocks? Great!
Here’s the best way to start: screen for stocks with market caps of < $1 billion, then read through every financial report from every company from A to Z. Too much work? Yeah, I thought so. It's much easier to call the markets efficient than to look through thousands of financial reports, but it's not as rewarding. This reminds me of Walter Schloss. He had no college education, and no financial background other than a single night class with Ben Graham. But by digging where no one else looked, he generated 15% annual compound returns against the S&P 500's 10% just because he dug deeper. Oh, and those returns were over a period spanning 5 decades. Seriously. Walter Schloss = 1.15^45 = 53,800% S&P 500 = 1.10^45 = 7,289% Finding stocks before Wall Street looks like a pretty good business to be in. 😉