Value Investing: Tools and Techniques for Intelligent Investment

Chapter 26. Bad Business: Thoughts on Fundamental Shorting and Value Traps^[26]

In the previous chapters, I've argued that the perfect short candidate has four characteristics: overvaluation, deteriorating fundamentals, poor capital discipline and bad accounting. However, I have neglected the more classical 'fundamental' aspects of good short opportunities. I think these can be grouped into three elements: bad managers, bad companies and bad strategies. These are clearly not mutually exclusive categories. For those who can't or don't short, these elements should help to distinguish between value opportunities and value traps.

• In his excellent book, Why Smart Executives Fail, Sydney Finkelstein identifies seven traits that poor management tends to display. I've called these the 'seven habits of highly defective managers'. In essence, poor managers see themselves as dominating their field, identify exceptionally closely with the firm, appear extraordinarily decisive, won't tolerate dissent, love being the face of the company, refuse to recognize any problem as more than temporary, and never hesitate to return to their past triumphs in terms of strategy.

• Many common behavioural traits seem to underlie these failures. For instance, overconfidence, confirmatory bias, conformity and self-serving bias all align closely with the habits that Finkelstein outlines. Perhaps analysts would be well served to conduct a behavioural audit of the management they cover.

• Intriguingly, there is now a relatively ...