We Study Billionaires - The Investor’s Podcast Network - TIP383: Exposing Bad Companies w/ Edwin Dorsey

Starting point is 00:00:00 You're listening to TIP. On today's episode, we are talking about how to expose a bad company. Our guest is the brilliant Edwin Dorsey, writer of the popular newsletter, The Bear Cave. Edwin takes us on a ride exploring the dark side of the stock market. Edwin first gained massive attention after successfully exposing Care.com for an unimaginable amount of negligence that ultimately led to the collapse of the stock. In this episode, we also cover some tools you need to identify suspicious. vicious companies, which are completely free, by the way. Edwin's research on companies such as

Starting point is 00:00:34 Ag Eagle and Root Insurance and so much more. Look, I'm not a short seller, but I found this discussion not only highly entertaining, but also extremely informative. I've now added some of these tools to my qualitative portion of due diligence, and I think you might as well. So, let's get into what makes a bad company with up-and-comer, Edwin Dorsey. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence sales made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to The Investors Podcast. I'm your host, Trey Lockerbie. And today, I'm super excited to have with me Edwin Dorsey on the show. Welcome to the show, Edwin. Great. Thanks so much for

Starting point is 00:01:28 having me on. I'm very excited to be here. We're really excited to have you here, Edwin, because we had recently just explored what makes a great business with Jim Collins. So I thought it would only be appropriate to explore the opposite end of the spectrum and expose some bad companies. You have made a career out of this, but why don't we start with what really put you on the map, which was your report on care.com. This is just a wild and fascinating story. So just give us top to bottom. Absolutely, Trey. It's a great story. So three years ago, I was a freshman, finishing up freshman year at Stanford. I was interested in the stock market. I had been talking to a few short sellers, so I was starting to learn about it. And I had a friend who was a babysitter on

Starting point is 00:02:11 Care.com, and I knew it was a publicly traded company. And she said, you know, something seems off about this site. I don't think they're vetting people, even though they claim to be vetting people. You should dig into them. So this is the first company I kind of sunk my teeth in and did a little research on there. They were the largest babysitting platform in the U.S. at the time, roughly a billion dollar market cap. The first thing I do is I pull up Pacer and I start looking at lawsuits against the company. And I see, hey, there's actually been a bunch of lawsuits against this company, a lot around safety issues, and then not letting babysitters, even when parents pay for background checks. And then I started looking at local news reporting. And there

Starting point is 00:02:50 was a lot of these issues where, like, somebody who had been arrested for drunk driving past Care.com's background check. And I'm like, huh, this seems a little odd. So I decided to test care.com screening for myself because you're a babysitting platform. Your ability to screen babysitters is very material to your business if you claim to be doing that. So I decided to try to sign up as Harvey Weinstein. I used Harvey Weinstein's photo. I made up an address and social security number for Harvey Weinstein completely fake account. I can send it to their background check. I documented the whole process. And at the end, they're like, we're going to get back to you within 48 to 72 hours on whether or not you're approved as a babysitter on Care.com. And I'm like, there's no way they

Starting point is 00:03:30 approve Harvey Weinstein if they're actually doing these background checks. Lo and behold, I was approved. And not only was I approved, I got to their like second highest level of authenticity. I got all these badges for being CPR certified and first aid certified. And I'm like, they're just not doing any of this betting they claim to be doing. So I put out a little report on them and I put it on my Twitter and it goes a little viral. The stock calls. The board member resigns the next day. And I'm like, okay, good. Two days later, I get an email from the dean of students at Stanford saying, we have to meet. We got to complain about your Wi-Fi usage. And I'm like, this is probably care.com related because, you know, I haven't gotten like too much trouble in the past.

Starting point is 00:04:09 And I go in and they're like, care.com's co-founder called and said you're messing with their site and you're harming their business and you need to take this article down right now because you violated Stanford's Wi-Fi policy. And I, you know, I'm like, how did I violate it? And they're like, well, you impersonated Harvey Weinstein and you violated their terms of service while using Stanford Wi-Fi. And I'm like, I'm not taking this down. They're like, you have to. And I say, no. I'm like, put it in an email. And I get that email. I go straight to the student newspaper. And I decide, you know, this is really weird. The company is like calling my college. I really start to dig in. I file a FOIA request with every state attorney general, 50 different FOIA requests for consumer complaints against care.com. I go to the NYPD and I file

Starting point is 00:04:51 a FOIA request for every time the word care.com had been used in a 911 transcript. So anytime somebody called 911 and used the word care.com. And then I wrote letters to every family that had ever called the police about care.com. I became obsessed and published a much longer article on Medium that got more attention, highlighting a lot of safety issues at the company, as well as other metrics where they were misleading investors. I sent that to a lot of journalists. The Wall Street Journal got interested in it. And to make a long story short, nine months later, the Wall Street Journal runs a front page story about these safety issues at care.com and how five kids were killed by Care.com babysitters who had prior criminal history.

Starting point is 00:05:31 So they had no business babysitting kids in the first place. This could have easily been prevented, but because Care.com fake doing background checks when they claimed to be doing real ones, kids got hurt. That article got a lot of attention. The CEO, CFO and general counsel resigned. The Stanford Dean that investigated me also resigned. The company sent a private investigator to my house, which was like, you know, another crazy thing in this whole story.

Starting point is 00:05:54 And the company ended up, the stock fell in half and it was sold to IAC at a small premium. And the good thing is the silver lining this story is after IACBodcare.com, they revamped the board and they really fixed a lot of the safety issues. I tried signing up again under fake accounts and they all caught it. So it's one example of how, like, you can actually kind of make a little bit of a difference if you're persistent and quirky and go after it. I think it also goes to show that activist short sellers sometimes at their best can benefit society. I was just about to say this is activism at its core. I mean, this is one of the most amazing stories. Just to confirm, you were actually short the stock during this whole time.

Starting point is 00:06:34 So I think it was short a stock. You need to be 21. And at the time, I wasn't even 21. So at one point, own put options, not for my first report, but for my second report. The sad thing is I ended up losing money on this whole ordeal because the stock went up while I was owning the put options and then collapsed only later. So I lost some money on this, but I gained a little bit of a Twitter following, which is coming here. So, all right, so let me get this straight.

Starting point is 00:07:01 You post a profile on care.com as Harvey Weinstein using his photo and they accept you with all the bells and whistles. And then we go beyond that and the CTO of care.com calls your college with the threat. He also then proceeds to sell $700,000 worth of shares. That's just fascinating. I'm also kind of curious where you go to look for inside trading like that. Is that a typical part of your practice or your checklist? You know, this is going to sound a little odd.

Starting point is 00:07:31 I've never paid that much attention to insider sales. I look them up. There's a website called Insider Score I use. You can find them on the SEC's Edgar database. I think oftentimes it's more noise than signal. If somebody sells half their stock, yeah, that'll be bad. But tons of companies that have performed well like Facebook have had really aggressive 10B51 executive selling plans.

Starting point is 00:07:52 Tons of companies that have performed poorly about a lot of insider buying. Well, one thing that I think is worth looking at is if you see cluster buying, like three directors, the CFO and CEO, particularly at microcaps, that can be interesting. I'm not great at this, but some people are really sophisticated at looking at anomalous option grants to say, hey, that could be a really bullish sign for a company. Generally speaking, though, insider selling and buying, I think is an overrated thing investors look at. Well, you threw out some terms there that I just want to cover because a lot of our audience

Starting point is 00:08:24 may or may not have heard of these things. So first of all, you said Pacer. That was the first place you went. So talk to us about what drove you to go there in the first place. Just looking up lawsuits, this is not necessarily a tool I've heard people throw out as the first thing on their checklist. So talk to us about that one and then I want to go from there. So pacer.gov is just a government website that allows any person to look up lawsuits

Starting point is 00:08:44 in certain courts against a company. It's pretty easy to use. You need to make an account. There's small fees associated with it, but it's never that material. And what you do after you make an account, which is free and government run, you just put in a company's name and you can say search like all federal courts. And it brings up most but not all lawsuits that are against the company. It's a little bit of a clunky system. And then you can like organize it by date file or whether or not the lawsuits are currently open.

Starting point is 00:09:13 There's some stuff that's sealed. Not everything, you know, is perfectly arranged. But oftentimes for like the cost of $3, you can just pull up a lawsuit against a company. Sometimes for major ones, most investors will see it or hedge funds will look at it, but oftentimes things are missed. And what you can do is you can use it as like an early stage of research to try to find like patterns. So if one person complains about being overbilled by a company, that might be an isolated incident. But if you see a lawsuit, you see online gossip, you test it out for yourself when something seems wrong. You start to form a mosaic that something's really wrong here.

Starting point is 00:09:46 So pacer.gov, I don't use it a ton, but it's a great cheap way to find lawsuits. Another site you threw out there was FOIA. So what you're referring to is FOIA or the Freedom of Information Act. Walk us through this tool and how it might be underutilized. So the Freedom of Information Act isn't a website. It's a law that dates back a while that allows any U.S. citizen to request information from their government. Journalists use it a ton to get confidential memos and items like that from the government or uncover political scandals.

Starting point is 00:10:18 The way investors would usually use it is if you're a, a biotech investor, you're going to send a lot of FOIA requests to the FDA, trying to get any little hint of information on whether or not a drug's going to be approved. If you're looking for an SEC investigation into a company, you might send a lot of FOIAs to the SEC to try to see if they can reveal through whether or not they approve or deny the request if there's an active investigation into the company. The way I usually use it and the way I think it is best to use it is to try to get consumer complaints against company.

Starting point is 00:10:49 So let's say there's a big company and you think they might have unfurbed, or deceptive trade practices. You can go to the FTC. Usually you file a FOIA request by sending an email fax or physical letter. And this information is online if you just Google FTC Freedom Information Act request. And you can send him an email saying, I want all complaints against this company within the last two years or all complaints, consumer complaints that use this word within the last two years. It varies by agency. Sometimes we'll email you back three days later saying here's a PDF with everything. Other times they might charge you a de minimis fee. like $20 to get the documents. Sometimes they'll mail you a physical CD. Sometimes it'll be an Excel

Starting point is 00:11:28 spreadsheet. I do a lot at the state level, so like state attorneys generals. So I might go to the New York State Attorney General's office, send them an email or use their portal to say, hey, I want all consumer complaints against MasterCard over the last two years. MasterCard's a huge company, so there's going to be a ton. But for smaller companies, you can get a lot of insightful information. For example, there's a company called Payneer, and I filed a FOIA request on Paynear, the small payments company. And they're like, we have 3,000 pages of complaints, half of which are IRS suspicious activity reports. It's going to take us two years to get back to you on this and it's going to be a $500 fee. And, you know, even though I haven't got the records yet,

Starting point is 00:12:07 just that information says, wait a second, there's something going on here. You've got a lot of problems for a small billion dollar payments company. So that's kind of the value of FOIA. And you You can use it in a lot of creative ways. And even the big smart money investors, I don't think are that sophisticated with. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord,

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Starting point is 00:16:33 Back to the show. All right. Well, let's go to one of the other companies you've recently reported on, which is route insurance. So talk to us about what's happened here. So, Tray, root insurance is like emblematic of the types of companies I look for. I look for companies that are misleading investors or hurting customers. And root insurance was doing well. Route insurance is a car insurance app. And their pitch to investors is, hey, you sign up for our app. We'll track your location 24-7 for two weeks. By doing that, we can differentiate the good drivers from the bad drivers

Starting point is 00:17:05 solely on phone geolocation. And based on that, we can only underwrite insurance to good drivers. We can see the times of day you drive. We can see the locations you drive. We can see the speed at which you're driving from the phone. We can see if you break hard or if you break in a normal way. It's your turning radius. We get all this data just from your phone on how well you drive.

Starting point is 00:17:26 That allows us to underwrite insurance in a really novel way. So we're only going to underwrite good drivers and we can get them better prices on that. And once we get scaled, it's going to be a massively profit. business. That's how it works in theory. In practice, what route insurance would do is they'd entice riders to sign up with really low rates. And when it comes up for renewal every six months, they always hike the price, almost always hike the price for silly reasons. Like they'll say the weather in your area has gotten worse or, you know, the cost of car repairs in your area has gotten worse. All these silly reasons when in reality, they're just hiking prices for the sake

Starting point is 00:18:02 of hiking prices. And in addition to hiking prices, they make it difficult to cancel. And that's where I have a big problem. It's one thing if you make, there's no phone number to call. There's no website to cancel. You need to do it through an app. So what I did when I was researching route, the first thing I do is I file a bunch of FOIA requests with state attorney general's credit. And I get hundreds of complaints. And it's kind of sad to see, you'll see like people who hire lawyers to send letters to insurance commissioners being like, my client has tried to call three times and they just can't cancel their insurance policy. I saw a letter oftentimes from minority communities to the state insurance commissioner saying, hey, you should revoke their license because too

Starting point is 00:18:42 many people are coming to me saying they're having problems with this insurance company. You see a lot of issues. And then from that, you can start the form a mosaic. These issues you get from the letters are anecdotal, but then you can go to the National Association of Insurance Commissioners. They have a website. And on the website, it showed that route insurance got about four times as many complaints as should be expected for a company of its size. And when you put it all together, it's like, huh, even though the financial metrics look good right now, these are raising prices on consumers. In the long run, it's going to perform poorly. I wrote an article on it when the stock was at like 20. Now it's at six because guess what? All these customers that you held captive found a way

Starting point is 00:19:20 to leave because that's what happens when you have unhappy customers. And that's kind of emblematic of the type of thing I look for. Wall Street thinks it's great because the metrics are looking good, but the customers hated and are angry. And that's what drives the long-term success of the business. You know, it's interesting because a similar metric that I'm used to using is something like the net promoter score. And there are a lot of examples where a company can have a very bad net promoter score, but then a very good stock, right? So Facebook comes to mind, right? Not a great promoter score. Some banks come to mind. How much attention do you pay to something like the net promoter score of a company.

Starting point is 00:19:55 So I pay a lot of attention to customer satisfaction. How that translates the net promoter score can be interesting. If a company is saying, hey, this is my net promoter score. I'm going to be super skeptical of it. For example, there's a company called Alphi. They give high interest loans, average interest rates of 120%. They claimed in their SPAC perspective to have a higher net promoter score than Apple and Ritz Carlton.

Starting point is 00:20:18 There's no way this company that's doing payday lending has that high of a net promoter for you might have hired some shady consultant to give you that number, but that's not a real number. I look a lot at customer satisfaction, but to your point, some businesses that have low customer satisfaction still perform well. So you want to look at the customer satisfaction compared to the investor consensus around that. So if everybody's aware, hey, this is a business that leaves a lot of unhappy customers, now that business might not be great for society, but the stock still has potential to do well. But if the investing public is like, hey, we think this is a normal insurance company that has happy customers, in reality, everybody's furious and is going to churn,

Starting point is 00:20:57 then that's some piece of novel information the market's missing. And once the market sees that in the financials, aka lower retention or lower revenue, that's when it's going to get priced in. And that's what I look for a lot when the financials show one thing, but you can tell it's about to change these customers are so unhappy. And as Jeff Bezos says, in the long run, the customer's interest and the company's interests are the same. That's true in most cases.

Starting point is 00:21:21 and that's what I believe firmly. So you wrote about this stock route back in December of 2020. It looks like the stock was trading somewhere around $20 a share, $18 to $20. Now it's trading around $6 a share. So is this another short of yours? And if so, my other question is, and a second follow question would be how the financials changed over the course of that time. So funny enough, try, even though I write a news that are popular with a lot of short sellers, I don't short any of the companies I write about.

Starting point is 00:21:50 I don't buy puts. I only make money from paid subscriptions to my newsletter. Some people find that odd. You know, I would say as a 23-year-old, I don't have a huge balance sheet. So I couldn't even make that money if I wanted to. It too, I think it gives it more journalistic integrity and it makes, it allows me to charge subscriptions from my newsletter. So I actually don't have a short position and never have. That said, one thing root has is a lot of debt. And if you look at the state level, all these states are having them issue like hazard reports and going kind of warnings about their financial position because as an insurance company, you have to be strong financially. Where it goes from here, I'm not entirely sure. I think it's played out in kind of the way I expected where the markets

Starting point is 00:22:29 noticed, hey, they actually do have a huge customer retention issue. And that's going to be a problem in the long run. No strong opinion on it now. One thing I'd note, though, is when it was at 20 and I put my report out, everybody was like, well, Tiger Global owns it. All these 10 big New York City hedge funds own it. Well, why are you, you know, how could they be wrong? But it helps. It helps you, happens a lot more often than you think where almost any big company that collapses has a lot of big name investors. That's something I found peculiar and I think I got the last laugh to a small extent there. So fascinating. Curious about, I'm wondering if there's been any turnaround on the tech side of route based on what they were misleading investors with. Are you still seeing that same kind

Starting point is 00:23:11 of issue at hand with the company? So the technology is really tough to evaluate. The way you would evaluate their technologies through underwriting performance. And underwriting performance just hasn't been good. They've taken a dollar of premium, they lose a dollar in 10 cents. You know, Metromile, their competitor, based on the conversations I've had with people in the industry, Metromile has the better tech. It's tough for me to say, just as an individual who doesn't understand this super well, but if you look at the underwriting performance as a proxy for the tech, it just hasn't done well. The rumor was that they tried to get acquired pre-IPO and no one would buy them, which is another sign that the tech isn't as great as they think.

Starting point is 00:23:50 Fantastic. All right. So the next company I want to cover is AgEagle Aerial Systems. Stock is UAVS. You reported on this earlier this year. What's happening at AgEagle? Great. AgEagle Aerial Systems is the most wild story I think I've ever seen.

Starting point is 00:24:07 At the time, it was like a billion-dollar company, ticker UAVS. And they claimed to make great drones that could be used for a wide variety of purposes to deliver Amazon packages, to scout land. At one point in time, they said, we're going to actually be very great with the cannabis industry. So you can use our drones to fly above farms, to find good areas for hemp fields, to grow marijuana. Just all these like wild uses for the supposedly great drones. And then, you know, that's how they're selling themselves to investors and online and what's going on in the chat rooms. You just open the 10k, their annual filing. And it's like they have 12 employees. How much do they spend in R&D $40,000? How many patents do they own like zero? It's like, wait a second, how can $40,000

Starting point is 00:24:52 of R&D translate to an incredible business? Something smells a little all. So, you know, I start to dig into it a little more. And it turns out the thing that made the stock price rocket from 1 to 15 is they got this big investment from a Liechtenstein based hedge fund called Alpha Capital Ansel. And you can look at the last 50 deals they've done, like half of them end with the company near bankruptcy. So this firm basically has been associated a lot with pump and dumps, even if they're not doing it themselves. So seeing that was a red flag. And then the thing that was really propelling the stock a lot higher was rumors that they had a partnership with Amazon incoming.

Starting point is 00:25:29 The CEO would always talk about a partnership with a major e-commerce player. The chairman's daughter created a YouTube video where the Amazon logo was next to the AgEagle Aerial Systems logo and that went viral on Reddit. And I'm like, wait, this isn't how like real companies operate. And then you could literally find a local news article where Amazon explicitly denied having a partnership with Agile Aerial Systems. There's like, we've never talked to this company. We have no relationship with them.

Starting point is 00:25:56 But the rumor kept persisting, even with an explicit denial because that was like in a local newspaper behind a paywall, no one paid attention. So I just put all these factors together, put it in a report. The stock's gone from now 15 to 3. And that is one where retail investors lost big because all these retail investors, which see these like mockups for a drone and see oh partnership with Amazon and would see the stock going up. This company was popular on Reddit and Discord and Twitter, but they all ended up losing big and Alpha Capital and Salt, the shady vision sign hedge fund probably made a lot of money.

Starting point is 00:26:30 And the saddest thing is you can look, you can find videos of the drone online and it's literally just a remote control plane with a GoPro taped on it. And it's like, how is this a billion dollar company, how is this getting so much attention? That's really problematic to me. A billion dollar company with seemingly 11 employees. Is this what I'm seeing here? Yeah, but what they do is, you know, you never say you have 11 employees. You're about to acquire a transformative acquisition that's going to bring you to 300 employees. And the number you see in the slide deck is going to be 300 employees. You have a contractor who makes these for you. So your total employee base, including contractors, through some weird metric, is 200.

Starting point is 00:27:11 Like, well, you can't fly in an SEC filing, and that's where you'll get the truth. There's like 12 employees. So what's coming to my mind is that image from Nicola of rolling a truck down the hill, or I would suppose as rolling this electric vehicle downhill. And total prototype that obviously wasn't operational. It's reminding me of that. Is that what I'm hearing from you? Is this a similar case?

Starting point is 00:27:32 It's similar. Now, I think Nicola is a very peculiar example to bring up because sometimes the truth is a lot more complicated than people think. So when people think of Nicola, it's, oh, they faked a truck rolling down a hill and they told investors they had a working truck when in reality they were just rolling a truck down the hill. That's actually like, I think, kind of far from what actually happened. Because the truck rolling down a hill happened two years before the company went public. So that wasn't a stunt to deceive investors who were investing in the stock. That was just like a promo video to build hype, not even like associated with any round that you were raising from private investors. So yeah, it's a stunt. It's wrong. Yeah, it's misleading. But a lot of companies do stunts that aren't exactly true to build hype. And, you know, Nicola actually does have a lot of real people involved. So that's one where you can look at like the surface level and say, oh, my God, they rolled a truck down the hell that didn't work. It's got to be a total zero. When in reality, wait, you did that when you were a younger company, well before IPO and now you have real leaders in

Starting point is 00:28:32 there. Maybe there is something there. So oftentimes, I'm always skeptical of everything, Trey. And that's kind of almost a counter example to me of something that seems like it has zero substance, but there's actually something there, whether it's worth $4 billion, who knows. So recently we had Tom Gaynor from Markell Corp on the show. And he touched on this a little bit about how to kind of filter out leadership teams, really is what it was, how to vet them out and know if they've got integrity or not. And he pointed at the debt level. So what I'm kind of curious about you and your approach is how you filter down to these stocks,

Starting point is 00:29:08 to write about in the first place. Obviously with care.com, that was more of a personal experience. It came across your radar. But since then, what's your approach as far as filtering down a universe of stocks into something? I'm curious, does it involve the level of debt? Trey, no. I'm going to give you the strangest answer in the world. None of your guests will say this, but a lot of my ideas come from really just two sources.

Starting point is 00:29:31 I'm a big Twitter fan. I think there's a lot of really smart people on Twitter. I've even published a list of the 100 best Twitter accounts to follow that share great ideas. There's a lot of these weird accounts with 50 followers, 100 followers, 500 followers. They're sharing like really good research uncovering one or two red flags. I follow all of them. I spend two hours a day on Twitter. I have a working list.

Starting point is 00:29:53 Anytime I see something a little suspicious, I add that to my working list. And we can discuss what I do once something gets on the working list. But that's how they pop up in one way. The second way they pop up is I'm a big fan of S&C. SEC comment letters. For those who don't know, SEC comment letters are informal correspondence between the SEC and a publicly traded company. They can be about a frivolous issue, like why is there this typo in this filing?

Starting point is 00:30:19 Or you can see these letters where it's like 15 questions just hammering them like, wait, there's a discrepancy. You said this number here, but this number here, you changed the way you recognized revenue, but you didn't close it to investors. Why did this person not sign this document? And sometimes you'll get like crazy answers. Like I saw one like Chinese education company and it's like the SEC is like, why did your CFO not sign this document? And they're like, oh, it was a typographical error.

Starting point is 00:30:47 Don't worry about it. And the CEO resigns the next day. The CFO resign. You're like, wait a second. Something's not right here. You've had three different CMOs. There's typographical errors. Let me dig in a little more.

Starting point is 00:30:58 So the two ways I find a lot of companies are Twitter, SEC comment letters. If the company has a lot of debt, specifically debt due soon, that is going to be of interest to me. But if the debt is due in 30 years, that's probably not going to play a huge role in the thesis. But to go back to the original question, I don't run screens. Maybe I should, but that's just not my style on how I do. Yeah, you seem to have a very qualitative approach, which I appreciate. Not a lot of people, though, would think to spend their time reading SEC comment letters.

Starting point is 00:31:27 So talk to us about where this drive comes from in the first place, where you studying investing investigative journalism? What is driving you to this dark side of the stock market? So, Trey, I've always been interested in stocks from a really young age. In second grade, I was all about stocks. My transition to the short side, the dark side happened freshman year of college. I, by coincidence, just got introduced to two the best short sellers out there freshman year. One is Mark Cajodes. He used to run a billion dollar fund and now is a private investor and he specializes in uncovering fraud. My other early mentor was Jim Carullers.

Starting point is 00:32:04 She runs a billion-dollar short-only fund called Sophos. I interned for him on and off for all four years. If your two early mentors are like kind of the greatest in the field, you're going to be drawn to that field. So I like to joke, if my two early mentors were microcap rates, I'd be here talking about microcaps. If my two early mentors were in private equity, I would have gone into private equity.

Starting point is 00:32:25 I just so happened to bump into two of the absolutely best short-sellers. and that they taught me a ton, they introduced me to the right people, and they kind of gave me, like, showed me how to do real research. And both of them, by the way, are very qualitative. Try to understand the company and its relationship with its customers. Modeling and looking at financials is the very last thing you do. That's like the afterthought. So a couple other companies that have been in the headlines a lot in the last year, especially, are companies like GameStop, our companies like Tesla, a few of these others. These are like just almost basic now, shorts, almost cliche in a way.

Starting point is 00:33:01 But it's interesting that I haven't seen your report on these stocks. What's your take? I know they're very different companies, but in the GameStop example, are you interested in companies that have a high level of short interest? Is that something that pops up on your radar? I love that question, Trey, because traditionally, what an academic would tell you, is a high level of short interest is correlated with really negative returns. Like, they add the 50 most heavily short of companies historically underperform the S&P 500 by like 10% a year.

Starting point is 00:33:29 So in theory, it's a good fishing pond. I'm actually turned off a lot by high short interest. I'll give you a few reasons why. One is there can be a short squeeze. And as you see from GameStop, it goes through 300 to 300. And it's like, so when it's high short interest, even if you think you're right, you need to make the position so small, it's counterintuitively almost better to get a low short interest name where you can make the position bigger. So something that is a high short interest, at most you want to make you like 1% of your fund.

Starting point is 00:33:57 But if you get conviction around ExxonMobil or a sleepy read or some boring stock, you know will never be a meme stock, then you can actually make it a bigger position in your fund and you can develop more conviction around it. So that's what I kind of like. Also, as somebody who's writing a newsletter, I want to focus on stuff that's off the beaten path because that's what provides value. I think there's a lot of group think on Wall Street, which is how you get the super high short interest and then that almost turns me off. What I'll also say is that there's super high

Starting point is 00:34:27 short interest. That means a lot of people have done a lot of work on the short side and a lot of people have done a lot of work on the long side. So in order to like be smarter than the market market, you need to do an extreme amount of work. And just as an individual, you're never going to get there. You might, you know, find one or two interesting things, develop a little bit of conviction. But if there's high short interest, that means there's some nuance or some complexity. You're never going to outsmart the market It just as an individual looking at a really high short interest name, or at least that's my view. You might, if you're relentless and you're smart and you really read stuff, do that in like a sleepy $1 to $5 billion U.S. company that a lot of people haven't looked down.

Starting point is 00:35:05 And that's exactly what I try to do. I look at $1 to $5 billion U.S. publicly traded companies that are sleepy, no one's paying attention to, and maybe our misleading investors are hurting customers. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform.

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Starting point is 00:38:46 the company, the who first principle, right? And even Warren Buffett, leadership is actually one of his four core values when he's looking at a company. Who is behind this company? Do they have integrity, et cetera? When you're going into these reports, how much time are you spending background checking of sorts, the leadership? And what are you teasing out of their commentary to distinguish if they have the kind of integrity you want or not? Absolutely. It's a big part of it. The first thing I usually do is I would try to watch a CEO interview, just to get a sense of the CEO. The more you do this, you can try to sense, are they in it for the money? Are they super passionate about it? This is their heart and soul. Somebody wants to equates it. You can put CEOs in two baskets. They're either a mother or a babysitter or a babysitter. You know, babysitters do the job, but mothers care about the child. You love the child. It's your thing. Are they a mom's CEO or it's their thing? Or are they a babysitter's CEO? their job. That's one thing you try to differentiate. The other thing is you can tell a lot between by past practice, by their historical performance. So one tool I like, and we haven't

Starting point is 00:39:50 talked about this yet, is the SEC full-text search tool. This is what I use to really dig deep in a CEO and a management team's history. So if you Google a CEO, you might find their LinkedIn, or you might find their bio on the company's website. But those are going to oftentimes boss over or leave out the bad experiences. I want to see the bad experiences if there are any. So this free website, the SEC full-text search tool that's run by the SEC, allows you to search any SEC filing that was published in the last 21 years. And what you do is you go to the SEC full-tech search website.

Starting point is 00:40:25 You can put in a name, put it in quotes, and it will literally show you every single time that name has appeared in any SEC filing for the last 21 years. And I'll do that for the CEO. And you'll see any time he worked for a public company, not just a CEO, but in any role, if he was a shareholder of a company, if he was a board member of a company. So if you've been a board member of three companies that have failed and now your CEO of one, you know, that's not a great sign. But I'll not stop there.

Starting point is 00:40:51 I'll also look at the CFO, the management team, and all the other orders. I found that if you have a board member who's associated with companies that only go to zero, their company's probably also going to zero. Because like, like, slight. So that's one thing I do. And that actually doesn't take a lot of time to use SEC full-tech search tool, put in the 20 names most important to the company and get a sense of their history. Very, very underused tool by investors, very underused tool by hedge funds that to me gives you the most comprehensive view of a management team. That's what drives the business, especially smaller businesses.

Starting point is 00:41:24 They'll have an outsized impact there. Wow. So just for fun, I pulled up this website while you're talking about it, the SEC full text. And what you're saying is you could pull up the name, the CEO. So let's just say Warren Buffett. We pull up Warren Buffett. And what you're looking for, you get this list of all kinds of documents, and you're going to, these SC-13 GA reports, beneficial ownership reports.

Starting point is 00:41:48 Okay, so walk us through clicking through these letters. And what are you looking for when you go into these documents? So Warren Buffett's going to be a tougher one, because he's mentioned in a ton of different filings. The first thing I do is I just see all the different companies he's mentioned in and just quickly, I don't even care how he's mentioned, just look up the share price performance for those companies. Now, Warren Buffett, again, is an anomalous example because there's so many and they're mostly big. But the first thing I do is like, okay, I see this executive has been mentioned by four

Starting point is 00:42:19 different companies in their filings. Let me just pull up the ticker and the chart and have they gone down to the right. Well, he's associated with a lot of companies that have performed poorly. Then you'd click on the document and see how was he associated. You need to be mindful. Sometimes people have the same name. You can't like say, oh, there's another Jim Smith who was associated with a lot of bad ones. This Jim Smith is bad. That's going to get you into trouble. But you click on the document and sometimes it's as simple as his LLC was a 1% shareholder of this company, not a huge deal. Other times, it's he was on the auto committee for this company and they had an accounting issue, bigger problem. So that's what I'll look for when I click the links. It's important to know

Starting point is 00:42:59 the SEC full-text search tool isn't limited to just names. Sometimes you can put a subsidiary his name in there. And it'll bring up like obscure like exhibits where like it is a contract between the subsidiary and something else. It's really this amazing tool that like no one uses and I tell everyone to use it. And then they're like, wait, it's kind of cool. So people should definitely check out the SEC full text search tool just to see how it works, even if you don't use it. All right. Well, we'll have a link to it in our show notes. Maybe Warren Buff is not a great example. Is there a recent name of sorts, maybe from one of your reports that helped flag you on a company to ultimately type up on?

Starting point is 00:43:39 So Ag Eagle, we referenced this a little earlier, but Ag Eagle, there was this hedge fund, Alpha Capital and Salt, that became their largest shareholder, that did a big equity deal. Hey, you know, how do you learn about this fund? You could put them in Bloomberg, nothing comes up other than their base in Lichtenstein. You can Google them and maybe one or two bad press articles comes up. But if you put in quotes, alpha capital and salt into the SEC full tech search tool, run it back 10 years or all 20 years, they'll come up 50 times. And this is where, you know, you can add a lot of value just by digging in. You'll see like the average share price performance of every company that does a deal with AgEgal Aerial Systems is like minus 40% per year, something like that.

Starting point is 00:44:21 We're like nine out of 10 really perform poorly. And that's like a massive red flag. And you can't find that any other way than using the SEC full-text search tool to find every single time this hedge fund's name appears in any SEC file. Then you see the full list of 40 companies they did deals with and you can investigate yourself. No other way to get that. Bloomberg won't do it. A web search won't do it.

Starting point is 00:44:45 Only the SEC full-text search tool will do it. And that's super valid. All right. So we've talked about a couple of the tools that you use. What is the first one that comes to mind? When you sit down to audit a company, what's the first tool? you pull up? When I'm first digging into a company, I'll alternate between a few. My favorite website is InsiderSport. Because our website is going to make it very easy to see executive

Starting point is 00:45:08 turnover. So I'll pull up that. I'll just type the ticker in and I'll see how many CEOs did they have in the last 10 years. How many CFOs did they have in the last 10 years? Have any directors resigned within two years of joining? He's a high level of resignation is a problem. Second thing I'll do is I'll look into the auditor of it, Trey. And this is another tool that. people don't use enough. It's called the PCAOB auditor search tool. It's public website. PCAOB is the public company accounting oversight board. It's a quasi-governmental agency that like regulates auditors. And people don't know this. You can type in any ticker and it pulls up what the auditor is and you know, who the auditor has been for the last five years. That itself is like actually

Starting point is 00:45:51 somewhat common knowledge on Wall Street. You can find it very deep in the 10-K. What people have no idea, no idea you can do is you can go to the PCAOB website. You type in a ticker. It brings up the auditor, but it also shows you the specific audit partner responsible for that audit, which is fascinating. So you don't just know which auditor is auditing the company. You know which person is auditing the company. And what I found is oftentimes like an auditor might have an okay reputation, but specific audit partners, only audit companies that go to zero. And that's a problem. So you can click on the specific auditor on the PCOB website and see every company they've audited

Starting point is 00:46:34 in the last four and a half years. And if you see, wait, they've audited six different companies, average share performance of like negative 90 percent, that's a problem. If they've audited five companies that are sub-50 million dollar companies and one company, that's a five billion dollar company, wait, that's a problem. What I think happens is every auditor, big four, not big four or whatever, will have some people who are just like ready to be disposed of, ready to be the fall guy if something goes wrong. And they're assigned to all the questionable audits.

Starting point is 00:47:04 Can I give you an example, try? Absolutely. So I want to go to the PCOB website right now. It's PCAOBUS.org. In the top right, there's a search button. Then you do auditor search. And there was a Chinese online education company, RYB education, that colloquial. lapse right after its IPO.

Starting point is 00:47:22 So you look up RYB and you can see in 2019, 2018 and 17, the auditor was Deloise Tush, China and the specific audit partner responsible for that audit was Lili Shan. And you look her up, you click on her and she's been responsible for auditing three different companies in the last five years. One was RYB education, which fell like 80%. One was Puxent, which is another online education company, which fell significantly. And the last one was GSX tech EDU, which is this other online education company that's collapsed like 90%. So if you were researching GSX or these other companies, you pull her up and wait.

Starting point is 00:48:02 The other two companies she's audits are also highly controversial and have collapsed. It's like, huh, this is problematic. And you just see this over and over specifically for China a lot. We're like specific audit partners, only audit companies that fall 90% or more. It's just fascinating. I think it's because auditors know, wait, this company is a little sketchy, so we're going to assign our, like, you know, fall guy person to it. And it's just terrible. But it's like, that's kind of how it works.

Starting point is 00:48:30 And not enough people are talking about it. And the crazy thing is smart hedge funds don't know about it, too. So there's all these, like, cool niche government websites that no one's using enough that all your listeners should use. What you're touching on there is, you know, causation and correlation, right? So you're correlating these auditors. And by the way, are they listed here as auditors? I'm also seeing engagement partner. Exactly.

Starting point is 00:48:53 That's the specific person responsible, yes. So you're correlated the engagement partner with the firms that are falling. And it's not that they are causing the stock to fall because they expose something in their audit. You're saying it's actually the latter or it's the opposite of sorts, perhaps, where they're putting almost like a less qualified person on the case. Is that correct? Yeah, precisely. This is precisely it.

Starting point is 00:49:20 So it's not like, oh, they have a bad audit partner, so their customers are going to be upset. No, no, no, no. It's that companies almost self-select and like get it, like, you know, we'll work behind the scenes to get the questionable audit partner who will sign off on anything. And if you're getting that person, then that means you probably push for it.

Starting point is 00:49:38 And that's a big red flag. And it just happens across the board. Like, I'm literally looking after one company now. I don't want to say its name, like 20, billion dollar entity. The audit partner has audited three companies that have like fell 90% penny stocks and one 25 billion dollar company. And it's like, how is a 25 billion dollar company like getting that done? Well, it's because they want somebody who's going to sign off on anything or they can pay huge fees. So, and that's a lot of what I do. So, you know, you look at bad directors.

Starting point is 00:50:09 Does a board member actually have that much of effect on a company? Probably not. But if If you find somebody who's been a board member on companies that have gone to zero in the past, then that probably means the people who recruited him on the board are bad, that the CEO wants a complacent board who's just going to get their checks and not ask question. So I do a lot of this stuff, which is not things that are going to cause the company to fail, but things that are highly correlated with the company failing. And that's kind of like my prism through the world where people will build super complex models. And I'm like, no, silly, just go to this government website and put in the ticker and I'll get you something so much more useful.

Starting point is 00:50:51 You know, we recently had Ben Mesrick on the show and he just wrote a book called Anti-Social Network. It was all about the GameStop saga with Reddit and Wall Street bets, etc. Ben even mentioned that this is really happening at hedge funds now where people have full-on Reddit analysts who are on there trying to anticipate, right, a short squeeze. Is something like Reddit on your radar at all as far as even uncovering companies or just looking out for companies that might be going short? So, Trey, I think Twitter is generally the better tool than Reddit. It's similar, but just the quality is generally higher on Twitter. I've been blown away with some of the research on Reddit, though.

Starting point is 00:51:29 If you wear a suit and work at a big hedge fund, you probably think, oh, it's all idiots living in basements saying to the mood, AMC. In reality, that's part of it. But there's actually really outstanding research being done and shared there if you know where to look. The GameStop stuff is actually a great example of that. If you go back, read the early stuff from Roaring Kitty, the guy who kind of predicted this all, it was remarkably well researched. She was like, well, COVID's going to help with game sales if people stay at home more.

Starting point is 00:51:57 And, you know, the biggest driver of new game sales are new consoles. And a lot of new consoles are all going to be released in this three month period. And that's going to help GameStop. and they currently have a two-year runway of cash, I'll get them to a five-year runway of cash, and they're at like one-tenth sales. So six months from now, this business is going to go from near a bankrupt

Starting point is 00:52:16 to actually having a five-year runway of cash and growing sales. The market's going to notice that, and then they have a chance to turn it around. And I'm like, this is a remarkably good thesis. I didn't buy any, and this guy couldn't have predicted the magnitude of the short squeeze, but it was just out there in the open, and this great, like, you know, A plus quality work.

Starting point is 00:52:37 And, you know, people still don't recognize that, you know, if you get this stuff crowdsource, there's a lot of nonsense, but there are like diamonds in the rough there. So I think everybody should use Reddit. Just type in the ticker and I look, scroll through everything. And more often than not, there's one useful thing. So in the words of Charlie Munger, invert always invert, right? So what I love about this approach is not so much that our listeners need to go out there

Starting point is 00:53:02 and start short selling stocks, because that's not something we often talk about or advise on our show. But what I do love about this approach is almost not starting with it, but ending with it with your diligence. So you find a great company, you filtered it down, the financials look good, you know, you're going through your basis. And then you cap it off with something like this, almost is just another part of your checklist to ensure that you've covered your basis and there's not in other risks that you haven't currently taken into account. So is this something that people should try to add to their personal approach, or should we just rely on folks like you who know a little bit more about what they're doing?

Starting point is 00:53:40 So it depends. There's elements you can do very easily. If you're investing in a concentrated portfolio and you actually care about understanding your investments, I would totally just play around with the full tech search tool, at least put the CEO's name. Seeing who the auditor and audit partner is takes like, you know, 10 seconds. It also depends on the area you play in. You know, as you'd expect, bigger companies tend to have less of these issues.

Starting point is 00:54:05 I found once you get above the $5 and $10 billion market cap, these extremely obvious red flags go away. So if you're playing in the sub $10 billion and especially like the sub $5 billion or sub one billion area, these tools will add a lot of value. If you're investing in Apple and Google and Facebook, these are really irrelevant. Facebook isn't going to have a board member who's been involved in a ton of frauds in the past. All these companies are going to have reasonably qualified auditors. This becomes like less of an issue.

Starting point is 00:54:34 But for super small companies, any investor doing it, I highly recommend. They can reach out to me on Twitter or over email and I'm happy to talk to people. And then if you're investing a significant amount, FOIA requests are almost market cap independent. Those can add value regardless of the size of the company. Well, Edwin, this has been so much fun. This is just part of the stock market I've not explored very often. and it's been really enlightening.

Starting point is 00:54:58 And you just have an incredible track record calling to some of these companies. So congratulations on that. Obviously, I have a knack for it. Before we let you go, I want to give you the opportunity to handoff to our audience where they can learn more about you, where they can follow along with what you're doing, anything else you want to share. Well, Trey, thank you. I had a lot of fun too.

Starting point is 00:55:15 My Twitter handle is at Stockjobber, Edwin Dorsey at Stockjabber. I tweet a lot about stocks, so that might be a fun thing to follow. I'm unique in that I don't work for a hedge fund. I'm not employed by anybody. I really just write a newsletter called the Barcate, which is focused on exposing corporate misconduct. There's a free email that goes out every week, and there's a paid tier for people who want more deep dive articles.

Starting point is 00:55:39 And so check out the Barricade newsletter if you're into this stuff at Stock Jabber on Twitter. And keep listening to this podcast because you guys do well too. Well, I will be subscribing, and I will be sure to grab a bucket of popcorn as I read it because it's highly entertaining. So thank you so much again, Ed, but let's do it again sometime. Absolutely. Thank you, Tre. All right, that was a lot of fun. If you're loving the show, please go ahead and follow us on your favorite podcast app.

Starting point is 00:56:04 And if you'd be so kind to leave us a review, we always love to hear from you. Edwin and I connected originally on Twitter, so feel free to find me there at Trey Lockerbie. And if you want to do your own due diligence, be sure to check out the TIP Finance tool. You can simply Google TIP finance and it should pop right up. And with that, we'll see you again next time. Thank you for listening to TIP. Make sure to subscribe to Millennial Investors. by the Investors Podcast Network

Starting point is 00:56:27 and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional, this show is copyrighted by the Investors Podcast Network.

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We Study Billionaires - The Investor’s Podcast Network - TIP383: Exposing Bad Companies w/ Edwin Dorsey

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