Mark Tier's Investor's Edge: Applying the Winning Investment Habits of the World's Master Investors

15 June 2006

Using Scuttlebutt to
Maximize Your Profits

This is a powerful investment tool
that requires one major “analytical”
talent: the ability to listen

Probably the most underrated, and often the most rewarding way of testing an investment idea is called “scuttlebutt.”

If you haven’t come across this term before, it doesn’t mean scrounging around in garbage cans (though, come to think of it, that might occasionally be a good idea). It means talking to a number of different people who know something about a company so you can put the pieces together into a comprehensive picture.

Sometimes, it’s even easier than that.

For example, my first encounter with the “scuttlebutt” technique was with a Hong Kong company called Giordano.

Despite its Italian name, Giordano is a chain of clothing stores started in Hong Kong by a very interesting entrepreneur called Jimmy Lai. It sells well-made, fashionable clothes very cheaply.

But what intrigued me about this company was that every time I walked into one of its Hong Kong stores, the staff were cheerful, they welcomed you, they didn’t hassle you to buy something — but they were always there when you needed help.

While this probably doesn’t sound like anything out of the box, in Hong Kong 20 years ago to walk into a shop like this was to experience culture shock.

I mean that literally. Back then, a tourist could go into a camera store loaded with thousands of dollars he intended to spend on expensive gadgets and be met with complete indifference — or worse. Shop assistants in Hong Kong back then made New Yorkers seem like they’d all graduated from charm school — with honors.

My reaction was: Wow! If someone can get Hong Kong Chinese shop assistants to act like this, this company is probably a fantastic investment.

So I visited a number of other Giordano stores in Hong Kong, and the experience was exactly the same. I remember reading an article about Jimmy Lai at that time. Apparently, he had no particular interest in clothing or fashion. What he’d done was study successful businesses like McDonald’s to figure out how they operated; looked for an empty niche in the market; and created a superbly organized business to fill it.

The story was getting better and better.

Around that time, I travelled to the Philippines and Malaysia. Both these countries are renowned for their happy smiling people who are always pleased to see you — and even delighted that you’ve come to visit their country. As it happened, Giordano had expanded into both these countries so naturally I wandered into their stores.

Imagine my surprise when, in both places, I was greeted with reactions varying between complete indifference and outright hostility for disturbing their siesta.

Something in the Giordano model had obviously gone wrong. Clearly, if they couldn’t motivate people who are naturally cheerful to be cheerful in their jobs, the investment prospects didn’t look so exciting after all.

Not investing in Giordano stock at that time, it turned out, was a very wise decision.

Philip Fisher and Scuttlebutt

Scuttlebutt was the key ingredient in the success of legendary investor Philip Fisher. There’s only so much you can learn about a company from reading its annual reports, he once said. To really get to know a company, you’ve got to get out and talk to people. Not just the company’s managers, but its employees, suppliers, retailers and customers. Often, the very best source of information will be the company’s competitors. After all, an executive is likely to give you a one-sided view of his own company, but he’ll happily tell you anything you want to know about his competitors. Another excellent source is ex-employees, who will no longer be restrained by any loyalties to their former employer.

In his book, Common Stocks and Uncommon profits, Fisher talks about the first time he used this approach to evaluate an investment. It was 1928, and radio stocks were hot. So he went and talked to buyers in several San Francisco department stores. They all agreed that Philco radio was the one that was flying off the shelves, while a company which was the darling of Wall Street sold a radio that customers didn’t really care much about.

Unfortunately for Fisher, Philco, which was the low-cost manufacturer, was privately-held so he couldn’t buy into it. But he was, nevertheless, gratified to watch the stock of the Wall Street favorite sink while the market went to new highs.

The “Thickburger” Turnaround

In early 2003 — a somewhat more contemporary example — New York-based fund manager Whitney Tilson bought stock in a company called CKE Restaurants at $3.49 a share.

A key component of his decision to buy was “scuttlebutt,” and 18 months later, the stock was $14 a share — four times higher.

CKE Restaurants owns the Carl’s Jr., Hardee’s and La Salsa fastfood chains. Whitney was skeptical at first as the company had been in trouble and its brands were sliding in the market. But the management had a turnaround plan which impressed him. Given its financials and so on, the company would be a great buy — if the management’s plans paid off.

But would they? And more importantly: how to determine that before everybody else knew about it and the stock was no longer a bargain?

A critical piece of the turnaround plan was the introduction of a new menu in the Hardee’s restaurants. And central to that menu was the new “Thickburger,” made from Angus beef and selling at a premium price. It was tested in 80 restaurants, and when the test was successful rolled out across the Hardee’s chain.

Whitney and a fellow investor spoke to several franchisees, called more than 30 restaurants around the country, as well as visiting stores in different states. They found a consistent story throughout: staff were happier, customers were happier, and most importantly of all, same-store sales in the restaurants with the new menu were mostly up 30%-40%, year on year.

Convinced he was onto a winner he and his friend loaded up — and more than quadrupled their money. Such can be the power of scuttlebutt in digging up information directly from the market that you can be sure hardly anyone else knows about.

[You can read Whitney Tilson’s own, more detailed, commentary on this investment and his use of scuttlebutt in the column he wrote for the Motley Fool.]

“Call Your Dentist!”

One of my investment coaching clients was interested in a company that is Australia’s leading supplier of amalgam — the stuff dentists use to fill your teeth. Or at least, used to use. Nowadays, most dentists use that new white filling material that is hardened with ultraviolet light. It’s been years since I’ve had a filling with amalgam.

Apparently, my client’s teeth were in better shape than mine, as this was a fact he was not aware of.

So we talked about scuttlebutt and its uses, and at the end of the session I urged him, “Call your dentist.”

The next few weeks, every time we talked, I would say, “Have you called your dentist yet?”

Eventually, he reported that his dentist had told him: “Oh, I haven’t used that stuff in years. I don’t know anyone who does anymore.”

While there may have been other reasons for being interested in this company, what attracted my client’s attention was its near-monopoly of this niche market. But, clearly, a monopoly in a declining, even residual market is not a recipe for a growth stock. So he lost interest.

Try Your Luck

While it may take more than one simple phone call to someone you already know to get the inside skinny on a company, there’s always more than one way to skin a cat. Make a list of the sorts of people linked to a company — suppliers, retailers, wholesalers, customers, employees and so on. Then ask yourself if you know anyone who fits into one of those categories — or if you know someone who might know someone who does.

Go to a trade show, go to a company annual meeting, or any other place where the people you would like to talk to are likely to be and try your luck.

And probably the easiest place to do this kind of research is at the retail level. Go into a shop as if you were going to buy something, and ask the sales person all sorts of questions — the obvious questions a customer would ask but make sure you slip in a few important questions like, “Well, which one is the best-selling brand?”

Feeling a little bit nervous about this approach? Pick some product in which you have absolutely no interest. And then go and talk to someone who sells it. If you’re not interested, you have no emotional involvement in the outcome; and will find it easier to walk out the door at any time.

The direct approach often works too. Like Philip Fisher, introduce yourself as an investor and explain why you’re there and what you want to know. Remember: people love to talk about what they know, and more often than not all they need is a willing audience.

When you’ve found the right person, there’s really just one ability you need to use scuttlebutt successfully as an investment tool: the ability to listen. — Mark Tier

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