Last week, I suggested the better we understand what firms are actually doing, the better we’ll get at selecting good investments. I ended, though, with a quandary. Few companies lay out their strategies for everyone to see. A method of gathering information from unconventional sources popularised well over half a century ago may help.
Philip Fisher used what he dubbed the scuttlebutt method to establish the strengths and weaknesses of companies, and whether they would make good investments. His book, Common Stocks and Uncommon Profits, first published in 1957, is an investment classic.
Fisher advocated talking to people: competitors, customers and suppliers, to get a rounded view of a company. He proposed quizzing research scientists, trade association executives, and ex-employees as well. People like to talk about their work, he said, but there was a catch.
Most investors simply aren’t in a position to pick up the phone and quiz executives and scientists. He told private investors about scuttlebutt to help them find professional advisers who employed the method, not least himself, I imagine!
Undaunted, I’ve been thinking how modern investors can get a rounded view of a company by using unconventional sources. There’s a lot more information about companies available to investors now than there was in Fisher’s day.
I’ve found all of these methods useful in the past, but perhaps I haven’t exploited them to the full.
The annual report
Maybe you don’t consider the annual report to be an unconventional source, but, if that’s true, you’re probably in the minority. I’d bet the vast majority of investors and speculators don’t read annual reports, and even more don’t get beyond the executive spiels at the front.
As well as the numbers and notes, the best bits are usually in the strategic report, the principal risks and uncertainties section, and the segmental report, but they’re drier and buried further within the document.
The Annual General Meeting
Small companies will often talk to small investors, but the one opportunity investors in all companies have to meet the board is the AGM. After the meeting it’s common for executives to mingle with shareholders. We can ask the nerdiest questions about their businesses, and, as Fisher might, other businesses.
Customers, suppliers and competitors
Studying firms that have a commercial relationship with those we’re investing in reveals more about the industry, and a firm’s strategy than studying it in isolation.
By one measure, Jet2holidays, a startup fifteen years ago, has stolen second place from venerable package tour operator Thomas Cook (TCG). But the results of Dart (DTG), the parent of Jet2, earned on routes from unfashionable northern airports largely ignored by the rest of the package tour business, is less than half the story.
Over the last decade, Thomas Cook’s progress has been impeded by financial instability, customer relations disasters, and store closures, a legacy of past mistakes and high costs its insurgent, and store-less, rival has not borne.
One company I mean to study is Headlam (HEAD), a flooring distributor, and customer of James Halstead (JHD), the vinyl flooring manufacturer I profiled two weeks ago. Of course, I’ve already studied James Halstead, a supplier of Headlam.
Businesses on a similar journey
Judges Scientific (JDG) heads my watchlist, but buying the shares feels like a step into the unknown because I’ve never owned shares in a company quite like it. Judges buys small manufacturers of scientific instruments and does little with them.
Appointees from the parent company sit on the boards of investments and agree budgets, but, by and large Judges is buying good companies that require little investment and harvesting the profits so it can buy more small companies. From a shareholder’s point of view its skill is buying these private companies cheaply.
One way of understanding where Judges is going may be to study bigger scientific and technical companies that have collected other companies for longer, for example Halma (HLMA), Diploma (DPLM), and Oxford Instruments (OXIG).
A friend in the business
Your friends can be providers of scuttlebutt even if they don’t work for the businesses you might invest in, as long as they are customers, suppliers or competitors.
A friend, a keen player of games, knew I thought Games Workshop (GAW), the creator of Warhammer, might be inadvertently killing the game in pursuit of profit. The company earns money selling miniatures, model soldiers used in Warhammer, but also collected by enthusiasts, many of whom have long since stopped playing.
While the most expensive, and, therefore, lucrative, models are usually bought for show, the game recruits new generations of modellers. My Friend in the Business has kept me up to date as the company has rekindled its interest in the game, by relaunching it, and sponsoring the biggest UK gaming convention.
Many small companies don’t make the pages of the Financial Times and operate in labyrinthine industries. MS International's (MSI) annual reports and websites say little about the products it manufactures, but Janes, the defence publisher, routinely reports on its Seahawk naval gun systems.
Likewise, the advertising industry is contending with a digital revolution while some of its biggest customers, giant firms like Unilever (ULVR) and Procter & Gamble (PG) doubt whether they’re getting their money’s worth. Campaign, is a good source for the bemused investor trying to make sense of the changes.
Competition & Markets authority investigations
One of the vexatious things about investigating Haynes (HYNS), the famous and declining motor manual publisher, was how little it says about the digital business it’s nurturing that supplies a different and largely (to me) invisible market: professional workshops. Ten years ago Haynes acquired a market leading European supplier of digital schematics but for reasons I couldn’t fathom it wasn’t a big name in the UK.
The veil lifted earlier this year when the UK market leader, Autodata, was bought out by a company that already owned Autodata’s only significant competitor E3-Technical. When the Competition & Markets Authority ruled that Autodata’s new owner would have to sell E3-Technical, Haynes emerged as the buyer. The CMA’s rulings, despite redactions, make fascinating reading, including the market share of Autodata (75-85%) and E3 Technical, and descriptions of their sales channels.
VP's (VP.) acquisition of Brandon Hire has triggered a CMA investigation, and I have high hopes the subsequent reports will be similarly revealing.
Forums and feedback
One of the few remaining joys of investing in retailers is you can visit their operations uninvited, at least the sales end. It’s even easier if they are online retailers. If, like Amazon (AMZN), they include customer reviews you can get instant feedback on the products of countless other firms. Online forums are also bountiful sources of information, and you can often find people discussing products by the simple expedient of searching for one product versus a competitor on Google.
Qualitative information like this must be treated with caution. People’s opinions are biased and, if you don’t know the context, scuttlebutt will mislead.
I was once emailed by a disgruntled employee of a company when he was told he and his colleagues were to be laid-off. The company was changing strategy, and, while the layoffs were terrible news for people connected with the old strategy, the new strategy was a success. My correspondent’s advice was to sell my shares, and had I taken it, it would have been one of my worst investment decisions.
I, like Phil Fisher, believe that, weighed judiciously, scuttlebutt can help us discover, buy, and hold good companies.
Happy New Year!
Contact Richard Beddard by email: [email protected] or on Twitter: @RichardBeddard
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.