Carson Block, Muddy Waters — “Blue Pill Investing”

By xiexgp@gmail.com, September 8, 2014

These are my notes and instant reactions from a presentation at the Value Investing Congress, the notes below might contain errors, paraphrases, incorrect quotes, or misinterpretations.

Most investors know Muddy Waters and Carson Block, who build his short-selling investment portfolio by pulling away the veil that covered up the many China frauds several years ago, most famously the Sinoforest debacle. And I love reading what short sellers write, because I want to know about these nasty things they’re trying to disclose — I have one position that has a substantial short interest, and it worries me but hasn’t turned me against the stock yet (that’s Ligand, LGND), but I generally avoid the high short interest stocks. So I’m curious to see what big red flags he looks for in finding short candidates.

Block says we live in the “age of venality” — greed and short-term thinking are more prevalent than they’ve ever been. He’s going to go through some companies whose stock price has collapsed and look at what the warning signs would have been for long investors… and then will go into one short stock that’s a good example of investors doing “blue pill” investing by willfully not looking at reality (“blue pill” is a reference to Keanu Reeves in the Matrix).

There is a category of management that’s dangerous — they are charismatic, they manage in short term ways, they have short-term incentives, the more successful they are the less willing they are to be held accountable. It’s easy to fall for their charm (that’s how many get to be a CEO) … the more they’ve been put on a pedestal, the harder it is for that person to back down and lose their genius title by admitting a mistake, so they dig holes deeper.

Look out for stage-managed conference calls — it’s good to keep management at a distance and not believe them personally. It’s also good to look out for monetizing management — insider selling doesn’t always mean something nasty, but it’s not a good thing.

Look at boards who have symbiotic relationships with their CEO — boards are insulated and not independent. And beware lawyers who represent the company, they don’t represent shareholders but represent the executives who hire them. And auditors, who fight transparency and do not detect fraud (by design), are rewarded, he says, for failure… and the ...

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