Lessons I Learned from Scott Fearon’s Dead Companies Walking

Scott Fearon is the founder of hedge fund Crown Capital Management, which he opened in 1991. Since then, he has shorted over two-hundred companies that eventually went bankrupt. Over his many short selling successes, suffice to say that Scott’s learned a thing or two. In his book, of which 100% of the proceeds are donated to charities that support disabled children, he teaches some of the common factors between all the Dead Companies Walking that he has shorted.

In this article I’m going to highlight some of my favorite lessons from the book. Here is my Dead Companies Walking review. 

Talk To Management!

This is the main lesson Scott tries to drive home throughout the book. Through his 20+ years running hedge fund Crown Capital Management, he has met with over 1500 corporate management teams, making that an average of more than one meeting with management per week over his entire career as a hedge fund manager. While many investors (like the team at Motley Fool Stock Advisor) consider management when picking stocks, Scott takes it a step further with the depth of his research.

This is one of the factors he believes gives him an edge, and a chief reason for his outperformance of the market indexes over a long period of time. Early in his career working at a Houston bank, Scott found a mentor in one of his value-focused superiors, Geoff Raymond, who when he was too enamored with his sophisticated financial models, would tell him:

“Get up and go outside, Scott, you’ll learn more in five minutes of talking to someone at a company than you will in a week crunching its numbers.” – Geoff Raymond

Stop Going “Excel Crazy!”

Doing due diligence as an investor usually takes hours of number crunching, reading of company reports, industry research, and other qualitative research. After spending 6 hours doing research and valuations of a stock, sometimes one can forget that they’re actually trying to value a real-life business. Some of the most obvious insights won’t show up in the numbers. A conversation with management can be the difference between viewing a stock as trading at a 50% discount, and viewing it as a value trap.

Scott recalls a hearing a talk from hedge fund manager Stephen Mandel where he emphasized the importance of managements and how many investors overlook this simple factor. Here’s a great quote from the book:

“Right at the top of the list was a very pithy maxim: “managements matter.” Too many investors, he explained, get so lost in the weds of a company’s financial results–recent earnings, projections, extrapolations, and other purely mathematical data–that they forget to study the thing that makes any company great (or terrible): the people running it. He called this fixation on evaluating numbers instead of flesh-and-blood managers going “Excel crazy.”” – Stephen Mandel

Wall Street Analysts Live in a Bubble

A Wall Street analyst, which, besides summer analysts, are the entry level positions in sell-side institutions. Most of them come from elite academic institutions like Harvard or Columbia and got their job right out of college. Most of their social group consists of other young, upper-class intellectuals–people like them. These are the same people writing all of the sell-side equity research reports that create Street consensus. Scott theorizes that this is a reason fad stocks are often favored on the Street.

He recalls a specific situation during the roller skating boom of the early 1990s. A company by the name of First Team Sports were one of the biggest producers of the skates, and was a hot stock on Wall Street. After seeing an absurdly optimistic presentation from the company about their growth projections, Scott phoned an analyst from Hambrecht & Quist, and she had this to say:

Scott: “Is this rollerblade thing for real or is it going to go the way of the Slinky and the Hula Hoop?

Analyst: “Oh no, rollerblades are here to stay. They’re huge and they’re only going to get more popular as time goes on.

Scott: [expresses skepticism about her claim]

Analyst: “Mark my words, Scott, in ten years’ time, for every one bike you see in the Golden Gate Park on a sunny day, you’re going to see ten people on rollerblades.”

Scott: “Let me ask you a question, do you rollerblade?

Analyst: “Absolutely! So do all my friends. I do it every morning before work. It’s the best workout you can get.

Scott warned that the average American is nothing like your average Wall Street analyst, who is “young, affluent, and hyper competitive.”

Over Reliance on Recent History

Throughout the book, Scott repeatedly refers back to a meeting Scott had with Jerry, an executive of offshore drilling company Global Marine. Jerry had a “magic chart” of Global Marine’s drilling rig utilization. During the meeting, the utilization was just below 70%, which to Jerry, indicated that Scott should “buy, buy, and buy some more.” He went on to explain that he’s “been in the business for decades, and 70 percent is always the bottom. It never fails.”

This over reliance on recent history was, Scott explained in the book, one of the hallmark traits of a Dead Company Walking. Of course, if Jerry’s “magic” utilization went back further than 20 years, there would be plenty of periods where utilization went below 70, and stayed there for years.

Scott calls this mistake “historical myopia.”

Other Lessons

I chose to highlight the lessons from the book that you won’t hear from your average interview with a short seller. Everyone interested in short selling knows that technological obsolescence, rising debt with declining revenues, or companies playing the “blame game” are signs of Dead Companies Walking.

Here are Scott’s other signs of a Dead Company Walking that I didn’t highlight in this review:

• Technological obsolescence
• Hypergrowth through financing acquisitions and new locations
• Out of touch leadership
• Playing the “Blame Game”