A Look Into How We Are Picking Stocks to Short For the Balance of the Year

For those who are new to my writings and research (those who
follow me should skip down to the next section), I have had
relatively strong results in ferreting out weak companies which the sell
side, the ratings agencies and the media consider “buys”, “conviction
buys”, and AAA/AA credits – only to collapse, be acquired on the cheap
or fall into bankruptcy less than a year later. Despite the painful
rides necessary to ride out volatile markets that absolutely ignore
fundamentals, in the end broke is broke and insolvent businesses tend
not to last very long. The list of companies called out as insolvent
against the rating agencies/sell side analysts/super smart billionaire
investment crowd include:

• Bear Stearns: Is this the Breaking of the Bear? and Lehman
  Brothers
  (Is
  Lehman really a lemming in disguise)
• Washington Mutual and Countrywide
• Hovnanian: Credibility
  is the Key to Success for a CEO � Hovnanian has Lost that Key: A
  letter to Mr. Hovnanian
• General Growth Properties: “GGP
  and the type of investigative analysis you will not get from your
  brokerage house“ (BoomBustBlog
  professional
  subscribers can download the entire GGP
  composite history in .pdf format)
• MBIA and Ambac:  A Super Scary
  Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton
• among approximately 50 other similar calls..

These calls provided 5 quarters in a row of phenomenal returns (see
performance) until the massive market melt-up of 2009 where we saw
fundamentals get thrown down the sewer drain while math and common sense
were turned on their respective heads. Well, guess what boys and girls…
Methinks math is back and it may be here to stay for a while.

The Latest BoomBustBlog Research

Continuing our Bankruptcy Search Series (see BoomBustBlog
Bankruptcy Search: Focus on British Petroleum and Collateral Damage
and The
BoomBustBlog Pan-European Sovereign Debt Crisis Bankruptcy Search) I
am moving on to the broad, non-financial sector in the US. Please keep
in mind that this is a list for bearish investors who wish to take short
positions, and thus does not aim to find the absolute weakest companies
but strives to find the companies whose share prices will drop the
farthest on a risk weighted basis. The share float, share price, market
cap, (over)valuation, cash flows, revenue growth, interest coverage, net
debt, etc. can (on a cumulative basis) trump outright insolvency –
particularly if the market has already priced such in. In essence, we
aim to find the next unpublicized financial collapse that can be
primarily captured with short equity positions and options, although CDS
investors can definitely benefit from the list as well.

After completing the first round of shortlisting in the non-financial
sector, we shortlisted 7 companies using the following process:

• Step 1:
  Retrieved data for a list of 1,415 companies with a market cap of more
  than $200 million and share price of more than $15
• Step 2
  – Excluded 516 companies with negative net debt, due to the relative
  strength of their balance sheets
• Step 3
  – Excluded 211 companies with positive average sales growth in
  2009-2011 as well as positive sales growth in last FY and FQ due to
  improving fundamental conditions. We added back in 17 companies with
  interest coverage less than our required benchmark, assuming that those
  improving conditions failed to stem the debt service bleeding.
• Step 4-
  Excluded 41 companies with small floats
• Step 5
  – Selected 161 companies which either had interest coverage less than
  our benchmark in 2009 or have net debt to market cap of more than 1.0x
  (insolvency based on market pricing).
• Step 6:
  Of the selected 161 companies, the 31 companies with the weakest
  interest coverage were then shortlisted. These 31 companies were
  analyzed individually by hand based on various financial, operational
  metrics, and 9 companies were selected for trend analysis. At this
  point, database scans become inaccurate and you need a seasoned,
  educated eye to peruse the footnotes of the filings and releases to
  catch the BSFP (BS in the fine print).
• Step 7:
  Based on a trend analysis and the debt maturity schedules of these 9
  companies, two companies – DIN US Equity and OTT US Equity were excluded
  owing to relatively stable earnings stream,  no major debt maturities
  in the near-term and the debt largely carrying fixed rates of interest
• Step 8:
  We have analyzed 6 companies out of the final shortlisted 8 comps and
  following are the key findings of these companies. Two comps are airline
  companies and their earnings stream is largely influenced by oil
  prices. Since the dynamics of this highly leveraged sector is different
  from most normal manufacturing businesses, we are looking deeper into
  these companies to come up with some empirical conclusions (this study
  has been completed and will be released as a follow-up analysis).

This is a snapshot of the initial 1,415 company initial scan along
with solvency metrics for each company.

This is presented as a live, embedded spreadsheet and is available,
free to all by clicking here (feel free to
register as well, its free – register then choose the free subscription option).
I urge all who may be bearish this summer to peruse the spreadsheet for
it contains the pricing and major solvency metrics for over 1400
companies whose shares have skyrocketed over the past year. As some may
realize, literally insolvent companies’ shares have participated in that
skyrocketing!

The following link reveals the key details behind the weak points of
the six shortlisted and analyzed companies (for subscribers
only): Non-Financial Retail Subscriber Short List

Pro and institutional subscribers can
access an expanded list of 33 companies here.

For those of you who have not registered or subscribed, there is
still a company of interest that I will share in case you feel Europe
will blow up and the US will hit a double dip recession. This is not
nearly a strong a candidate as any of the subscription analyzed
companies, but it is worth discussion.

Comments

[Gimp]

Sum it all up in one word - SELL

[LebowskisURBANa...]

Classic worthless bullshit.

[whiteshadow]

Mr. Reggie,

feels great reading your post as usual.....but m still wandering when will you get to me, like you said in previous emails. greatly hoping to join your team. would appreciate if I could get in touch with you.

[BumpSkool]

ummm...ahhhh... Am I supposed to decide if each and every one of those 900 might fit the situation we're in, and then go short the appropriate ones ????

Hold on - I'll just be 18 months... 

(or do I just subscribe?)

[egdeh orez]

Thanks for sharing Reggie!

Just a quick question: what's your reasoning for using "Net Debt/Market Cap" as a screening ratio? 

[the grateful un...]

the larger the market cap the more vulnerable the company is to forced liquidation. When the margin calls come in you have to sell what you have. This is one reason probably why the phony rally since the crash has been in some of the least likely balance sheets. investors sell market cap in collapse, and crappy companies without any are less likely to get thrown in front of the bus..

[egdeh orez]

I'm sure this is not the reason.  You're trying to tell me that msft is more likely to go bankrupt than small cap companies because of its large market cap?

[Don Mattingly]

Where is the list of 7? The initial list of companies is like throwing darts at a dartboard.

[singlemalt]

This is typical Reggie forum-spamming.  Ignore him and he'll go away (eventually).

[Weltanschauung]

"Terrorists, serial killers, and mass murderers can be phenomenologically described as narcissists in a constant state of deficient Narcissistic Supply."

I wouldn't worry... your current stock might last awhile