Identifying A Bad Business w/ Edwin Dorsey (TIP383)
Trey Lockerbie (00:03): 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 companies, which are completely free, by the way. Edwin’s researched on companies such as AgEagle, and Root Insurance, and so much more. Trey Lockerbie (00:38): 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. Trey Lockerbie (01:17): Welcome to The Investor’s 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. Edwin Dorsey (01:27): Trey, thanks so much for having me on. I’m very excited to be here. Trey Lockerbie (01:31): 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. So 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. Edwin Dorsey (01:56): Absolutely, Trey. And it’s a great story. So three years ago, I was a freshmen 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 Care.com. And I knew it was a publicly traded company. And she said, “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.”
Edwin Dorsey (02:23): So this is the first company I sank my teeth in and did a little research on. They were the largest babysitting platform in the US at the time, with 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 them not vetting babysitters even when parents pay for background checks.” And then I started looking at local news reporting, and there were a lot of these issues where somebody who had been arrested for drunk driving passed Care.com’s background check.
Edwin Dorsey (02:56): I’m like, “Huh, this seems a little odd.” So decided to test Care.com’s 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, a completely fake account. I consented 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 through as a babysitter on Care.com.” Edwin Dorsey (03:29): And I’m like, “There’s no way they approve Harvey Weinstein if they’re actually doing these background checks.” Lo and behold, I was approved. And not only was I approved, but I also got to their 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 vetting they claim to be doing.”
So I put out a little report on that when I put it on my Twitter and it goes a little viral, the stock falls, a board member resigns the next day. And I’m like, “Okay, good.” Edwin Dorsey (03:56): Two days later, I get an email from the dean of students at Stanford saying, “We have to meet, we got a complaint about your wifi usage.” And I’m like, “This is probably Care.com related because I haven’t gotten in too much trouble in the past.” 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. You need to take this article down right now because you’ve violated Stanford’s wifi policy.” And 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 wifi.” Edwin Dorsey (04:29): And I’m like, “I’m not taking this down.” And they’re like, “You have to.” 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,
“This is really weird, the company is calling my college, so 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 NYTD and I file 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. Edwin Dorsey (05:04): I became obsessed and I 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. So they had no business babysitting kids in the first place. Edwin Dorsey (05:34): This could have easily been prevented, but because Care.com faked doing background checks and 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 another crazy thing in this whole story. 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 of this story is, after IAC bought Care.com, they revamped the board and they really fixed a lot of the safety issues. Edwin Dorsey (06:07): I tried signing up again under the fake accounts and they all caught it. So it’s one example of how you can actually make a little bit of a difference if you’re persistent and perky and go after it. I think it also goes to show that activist short-sellers sometimes out their best can benefit society. Trey Lockerbie (06:24): I was just about to say it. This
is activism at its core. This is one of the most amazing stories. Just to confirm you were actually short the stock during this whole time? Edwin Dorsey (06:33): I think to short a stock, you need to be 21. And at the time, I wasn’t even 21. At one point, I owned 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 money on this, but I gained a little bit of a Twitter following, which has come in handy. Trey Lockerbie (06:59): All right. So let me get this
straight. 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 curious where you go to look for insider trading like that. Is that a typical part of your practice or your checklist? Edwin Dorsey (07:30): This may sound a little odd, 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 10b5-1 executive selling plans. Tons of companies that have performed poorly have had 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.
Edwin Dorsey (08:05): 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 it’s an overrated thing investors look at. Trey Lockerbie (08:20): Well, you threw out some terms there that I just want to cover because a lot of our audience 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 throughout as the first thing on their checklist. So talk to us about that one and then we’ll go from there. Edwin Dorsey (08:39): So pacer.gov, it’s just a government website that allows any person to look up lawsuits in certain courts against a company. It’s pretty
easy to use. You need to make an account. There are 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 ran, 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.
Edwin Dorsey (09:13): There’s some stuff that’s sealed, not everything is perfectly arranged. But oftentimes, for the cost of $3, you can just pull up a lawsuit against a company. Sometimes for major ones, most investors will see it are hedge funds and 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 and something seems strong, you start the formal mosaic that something’s really wrong here. Edwin Dorsey (09:46): So pacer.gov, I don’t use it a ton, but it’s a great cheap way to find lawsuits. Trey Lockerbie (09:52): Another site you threw out there was FOIA. So what you’re referring to is F-O-I-A. or the Freedom of Information Act. Walk us through this tool and how it might be underutilized. Edwin Dorsey (10:02): So the Freedom of Information Act isn’t a website, it’s a law that they stack a while that allows any US citizen to request information from their government. Journalists use it a ton to get confidential memos and items like that from
the government to uncover political scandals. The way investors would usually use it is, if you’re a biotech investor, you’re going to spend a lot of FOIA requests to the FDA, trying to get any little hint of information on whether or not a drug is 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 to the company. Edwin Dorsey (10:42): 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 a company. Let’s say there’s a big company and you think they might have unfair and deceptive trade practices. You can go to the FTC. Usually, you file a FOIA request by sending email fax, or physical letter,
and this information are online if you just Google FTC, Freedom of Information Act request, and you can send them an email saying, “I want all complaints against this company within the last two years, or all complaints, consumer complaints that used this word within the last two years.” Edwin Dorsey (11:13): It varies by agency. Sometimes they’ll email you back three days later saying, “Here’s a PDF with everything.” Other times they may 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 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. Edwin Dorsey (11:48): For example, there’s a company called Payoneer and I filed a FOIA request on Payoneer, the small payments company. And they’re like,
“We have 3000 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 even though I haven’t got the records yet, just that information says, “Wait for a second, there’s something going on here. You got a lot of problems for a small billion-dollar payments company.” So that’s the value of FOIA. And 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 it. Trey Lockerbie (12:24): All right. Well, let’s go to one of the other companies you’ve recently reported on, which is Root Insurance. So talk to us about what’s happened here. Edwin Dorsey (12:33): Trey, Root Insurance is 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 both. Root 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 solely on phone geolocation. And based on that, we can only underwrite insurance to good drivers because 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 brake hard or if you break in a normal way. We can see your turning radius.” Edwin Dorsey (13:12): “We get all this data just from your phone on how well you drive, which 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 to scale, it’s going to be a massively profitable business.” That’s how it works in theory. In practice, what Root 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 hiked the price, almost always hiked the price for silly reasons. Like they’ll say, “The weather in your area has gotten worse, or the cost of car repairs in your area has gotten worse.” Edwin Dorsey (13:48): All these silly reasons, when in reality, they’re just hiking prices for the sake of hiking prices. And in addition to hiking prices, they make it difficult to cancel. And that’s where I have a big problem. 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 Root, the first thing I’d do is I’d file a bunch of FOIA requests with state attorney generals, Trey. And I’d get hundreds of complaints. And it’s sad to see,
you’ll see people who hire lawyers to send letters to insurance commissioners being like, “My client has tried to call three times because they just can’t cancel their insurance policy.” Edwin Dorsey (14:25): I saw a letter oftentimes from minority communities to the state insurance commissioner saying, “Hey, you should revoke their license because too 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 of 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 Root
Insurance got about four times as many complaints as should be expected for a company of its size. Edwin Dorsey (14:53): And when you put it all together, it’s like, huh, even though the financial metrics look good right now because they’re 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 to leave because that’s what happens when you have unhappy customers. And that’s emblematic of the type of thing I look for. Wall Street thinks is great because the metrics are looking good, but the customers hated it and they’re angry, and that’s what drives the long-term success of a business. Trey Lockerbie (15:24): 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. Facebook comes to mind, 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? Edwin Dorsey (15:45): I pay a lot of attention to customer satisfaction. How that translates to Net Promoter Score can be interesting. If a company is saying, “Hey, this is my Net Promoter Score.” I want to be super skeptical of it. For example, there’s a company called OppFi. They give high-interest loans, average interest rates of 120%. They claimed in their stock prospectus to have a higher Net Promoter Score than Apple and Ritz Carlton. There’s no way this company that’s doing payday lending has that high of a Net Promoter Score. You might’ve hired some shady consultant to give you that number,
but that’s not a real number. I look at a lot of customer satisfaction. Edwin Dorsey (16:19): 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 of, “Hey, this is a business that leaves a lot of unhappy customers,” that business might not be great for society, but the stock still has the 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, then that’s some piece of novel information the market’s missing.
Edwin Dorsey (16:50): And once the market sees that in the financials, AKA lower retention or lower revenue, that’s when it’s going to get placed 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 because 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 and that’s what I believe.
Trey Lockerbie (17:13): So you wrote about this stock, Root, 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-up question would be, how the financials changed over the course of that time. Edwin Dorsey (17:32): Funny enough, Trey, even though I write a newsletter popular with a lot of short-sellers, I don’t short any of the companies I write about, I don’t buy puts. I only make money from paid subscriptions to my newsletter. Some people find that odd. 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 get to. I think it gives it more journalistic integrity, and it allows me to charge subscriptions for 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 warnings about their financial position because as an insurance company, you have to be strong financially. Edwin Dorsey (18:13): Where it goes from here, I’m not entirely sure. I think it’s laid out and the way I expected where the market’s 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. How could they be wrong?” But it 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. Trey Lockerbie (18:51): So fascinating. I’m wondering if there’s been any turnaround on the tech side of Root, based on what
they were misleading investors with. Are you still seeing that same issue at hand with the company? Edwin Dorsey (19:03): 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’d taken a $1 of premium,
they lose $1.10. 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-IPL and no one would buy them, which is another sign that the tech isn’t as great as they think.
Trey Lockerbie (19:40): Fantastic. All right. So the next company I want to cover is AgEagle Aerial Systems, the stock is UAVS. You reported on this earlier this year, what’s happening at AgEagle? Edwin Dorsey (19:53): AgEagle Aerial Systems is the wildest story I think I’ve ever seen. 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, the scout land. At one point in time, they said, “We’re going to actually be very great with the cannabis industry because you can use our drones to fly above farms, to find good areas for hemp fields, to grow marijuana.” Just all these wild uses for the supposedly great drones. And then that’s how they’re selling themselves to investors and online and what’s going on in the chat rooms. Edwin Dorsey (20:30): You just open the 10-K in their annual filing, and it’s like they have 12 employees. How much did they spend on R&D? $40,000? How
many patents do they own? Like zero. It’s like, “Wait for a second, how can $40,000 R&D translate to an incredible business? Something smells a little.” So I start to dig into it a little more. And it turns out the thing that made the stock price rocket from one to 15 is they got this big investment from a Lichtenstein-based hedge fund called Alpha Capital Anstalt. And you can look at the last 50 deals they’ve got, like half of them end with a company near bankruptcy.
Edwin Dorsey (21:03): So this firm basically hasn’t 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. 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 actual AgEagle Aerial Systems’ logo, and that went viral on Reddit. And I’m like, “Wait, this isn’t how real companies operate.” Edwin Dorsey (21:34): And then you could literally find a local news article where Amazon explicitly denied having a partnership with AgEagle Aerial Systems. It was like, “We’ve never talked to this company. We have no relationship with them.” But the rumor kept persisting, even with an explicit denial, because that was like in a local newspaper behind a paywall and 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 three. And that is one where retail investors lost. All these retail investors would see these like mock-ups for a drone and see, “Oh, a partnership with Amazon,” and this stock going off. Edwin Dorsey (22:10): This company was popular on Reddit and Discord and Twitter, but they all ended up losing big and Alpha Capital Anstalt, this shady Lichtenstein hedge fund probably made a lot of money. And the saddest thing is, you can look, you can find videos of the drone online and it’s literally just a remote-controlled 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.
Trey Lockerbie (22:36): A billion-dollar company with seemingly 11 employees. Is this what I’m seeing here? Edwin Dorsey (22:41): Yeah. But what they do is you never say, you 11 employees. You’re about to acquire a transformative acquisition that’s going to bring you to 300 employees. And then 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, there’s some weird metric, is 200. Well,
you can’t lie in an SEC filing and that’s where you’ll get the truth, there’s like 12 employees. Trey Lockerbie (23:07): So what’s coming to my mind is that image from Nikola of rolling a truck down the hill, or I would suppose as rolling this electric vehicle down a hill. A 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? Edwin Dorsey (23:22): It’s similar. Now, I think Nikola is a very peculiar example to bring up here. Sometimes the truth is a lot more complicated than people think. When people think of Nikola it’s, “Oh, they faked a truck rolling
down a hill and they told the investors they had a working truck when in reality, they were just rolling a truck down the hill.” That’s actually, 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 a promo video to build hype, not even associated with any round that you were raising from five investors. Edwin Dorsey (23:58): So, yeah, it’s wrong, yeah, it’s misleading. But a lot of companies do stunts that aren’t exactly true to build hype, and Nikola actually does have a lot of real people involved.
So that’s one where you can look at the surface level and say, “Oh my God, they rolled the truck down a hill 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 there, maybe there is something there.” So oftentimes. I’m always skeptical of everything, Trey, and that’s almost like a counterexample 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? Trey Lockerbie (24:38): Recently, we had Tom Gayner from Markel Corp on the show, and he touched on this a little bit about how to filter out leadership teams, which 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 curious about you and your approach is how you filter down to these stocks 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 the universe of stocks into something? I’m curious, does it involve the level of debt? Edwin Dorsey (25:12): Trey, no. I want 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 resources. I am a big Twitter fan. I think there’s a lot of really smart
people on Twitter. I’ve even published the list of the hundred 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 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.
Edwin Dorsey (25:43): 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 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? 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 recognize revenue, but you didn’t pose it to investors. Why did this person not sign this document?”
Edwin Dorsey (26:24): And sometimes you’ll get crazy answers. I saw one Chinese education company and SEC is like, “Why did your CFO not sign this document?” And they’re like, “Oh, it was a typographical error, don’t worry about it.” And the CEO resigns the next day. The CFO is like, “Wait a second, something is not right here. You had three different CFOs, there are typographical errors, let me dig in a little more.” So the two ways I find a lot of companies are Twitter, SEC comment letters. If a 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 thesis. Edwin Dorsey (27:02): But go back to the original question, I don’t run screens, maybe I should, but that’s just not my style and how I do.
Trey Lockerbie (27:09): You see 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. So talk to us about where this drive comes from in the first place. Were you studying investigative journalism? What is driving you to this dark side of the stock market? Edwin Dorsey (27:28): Trey, I’ve always been interested in stocks from a really young age. Like in second grade, I was all about stocks. My transition to the short side, the dark side, happened in my freshman year of college. I by coincidence just got introduced to two of the best short-sellers out there freshman year. One is Marc Cohodes. 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 Carruthers who runs
a billion-dollar short-only fund called Sophos. I entered for him on and off for all four years. If you’re too early mentors, are the greatest in the field, you’re going to be drawn to that field. Edwin Dorsey (28:05): So I like to joke if my two early mentors were micro-cap rates, I’d be here talking about micro-caps. If my two early mentors were in private equity, I would have gone into private equity. 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 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, it’s the very last thing you do. That’s like the afterthought. Trey Lockerbie (28:37): A couple of other companies that have been in the headlines a lot in the last year, especially, are companies like GameStop, are companies like Tesla, few of these others. These are like just almost basic now shorts, almost cliché in a way,
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? Edwin Dorsey (29:03): I love that question, Trey. Traditionally, what an academic would tell you is a high level of short interest is correlated with really negative returns. The 50 most heavily shorted companies historically underperformed the S&P 500 by like 10% a year. 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 to be a short squeeze, and as you see from GameStop, it goes to three to 300. When it’s high-short interest,
even if you think you’re right, you need to make the position so small, it’s, counter-intuitively, almost better to get a low short interest name where you can make the position bigger. Edwin Dorsey (29:42): So something that has a high-short interest at most, you want to make it like 1% of your fund. But if you get conviction around Exxon Mobile or [inaudible 00:29:50] 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. That’s what I 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 groups that think on Wall Street, which is how you get the super high short interest. And then that almost turns me off.
Edwin Dorsey (30:15): We’ll also say, is if they’re super high 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 be smarter than the market, you need to do an extreme amount of work. And just as an individual, you’re never going to get there. You might 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 just as an individual, looking at a really high short interest name. At least that’s my view. Edwin Dorsey (30:46): You might if you’re relentless and you’re smart and you really read stuff do that in a sleepy one to $5 billion US company people haven’t looked out. And that’s exactly what I try to do. I look at one to $5 billion US publicly-traded companies that are sleepy,
no one’s paying attention to, and maybe are misleading investors or traded companies. Trey Lockerbie (31:06): When we talk about what makes a great company, in the eyes of someone like Jim Collins, for example, he’s big on who’s in the company, the who first principle. And even Warren Buffet, 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, etc. When you’re going into these reports, how
much time are you spending, background checking of source, the leadership? And what are you teasing out of their commentary to distinguish if they have the kind of integrity you want or not? Edwin Dorsey (31:36): 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? Is this their heart and soul? Somebody once equates it, you can put CEOs in two baskets, they’re either a mother or a babysitter. Babysitters do the job and mothers care about the child, they love the child. It’s your thing. Are they a mom CEO where it’s their thing or are they a babysitters CEO where it’s their job? That’s one thing to try to differentiate. Edwin Dorsey (32:08): 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 talked about this yet, is the SEC Full-Text Search tool. This is what I use to really dig deep into 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, 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,
it’s run by the SEC, allows you to search any SEC filing that was published in the last 21 years. Edwin Dorsey (32:48): And what you do is you go to the SEC Full-Text Search website, you can put in their name, but the info, and it will literally show you every single time that name has appeared in an SEC filing for the last 21 years. And I’ll do that for the CEO. And you’ll see, anytime you work for a public company, not just the CEO, but in any role, if he was a shareholder of a company if he’s a board member of a company. So if you’ve been a board
member of three companies that have failed and now you’re CEO of one, that’s not a great sign. But I’ll not stop there, I’ll also look at the CFO, the management team, and all the other workers. Edwin Dorsey (33:23): I found that if you have a board member who’s associated with companies that only go to zero, your company probably also going to zero because likes likes like. That’s the one thing I do. And that actually doesn’t take a lot of time, but use SEC Full-Text Search, 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, they’ll have an out-sized impact there.
Trey Lockerbie (33:54): Well, so just for fun, I pulled up this website while you’re talking about the SEC Full Text. And what you’re saying is you could pull up the name, the CEO, let’s just say, Warren Buffet. We pull up Warren Buffet, 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. So walk us through clicking through these letters and what are you looking for when you go into these documents? Edwin Dorsey (34:22): Warren Buffet’s going to be a tougher one because he mentioned it 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. 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 different companies in their filings, let me just pull up the ticker and the chart, have they gone down to the right? Well, he’s associated with a lot of companies that have performed poorly.”
Edwin Dorsey (34:56): Then you click on the documents, how was he associated? You need to be mindful, sometimes people have the same name. You can’t like to say, “Oh, there’s another Jim Smith who’s 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, he was on the audit committee for this company and they had an accounting issue, bigger problems. So that’s what I’ll look for when I click the links. Edwin Dorsey (35:25): It’s important to note, the SEC Full-Text Search tool isn’t limited to just names, sometimes you can put a subsidiary’s name in there, and it’ll bring up obscure like exhibits where it is a contract between the subsidiary and something else. It’s really this amazing tool that no one uses. And I
tell everyone to use it and then they’re like, “Wait, it’s 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. Trey Lockerbie (35:52): All right, well, we’ll have a link to it in our show notes. Maybe Warren Buffet’s not a great example. Is there a recent name of sorts that may be from one of your reports that helped flag you on a company to ultimately type upon? Edwin Dorsey (36:05): AgEagle, we referenced this a little earlier, but AgEagle, there was this hedge fund, Alpha Capital Anstalt that became the largest shareholder that did a big equity deal. Hey, how do you learn about this fund? You could put them in Bloomberg, nothing comes up other than they’re based in Liechtenstein. You can Google them and maybe a one or two bad press articles comes up. But if you put in quotes,
“Alpha Capital Anstalt” into the SEC Full-Text Search tool, run it back 10 years or all 20 years, they’ll come up 50 times. And this is where you can add a lot of value just by digging in. Edwin Dorsey (36:38): You’ll see as the average share price performance of every company that does a deal with AgEagle Aerial Systems is like minus 40% per year, something like that, where nine out of 10 really performed poorly. And that’s a massive red box. 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 at any SEC filing. 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, only the SEC Full-Text Search tool will do it. And that’s a super value. Trey Lockerbie (37:16): 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? Edwin Dorsey (37:24): Well, when I’m the first day into a company, I’ll alternate between a few. My favorite website is Insider’s Forum. Insider’s website is going to make it very easy to see executive 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? Is a high level of Brexit nations the problem? The second thing I’ll do is I’ll look into the auditor a bit, Trey. And this is another tool that people don’t use enough. It’s called the PCAOB Auditors Search Tool. It’s the public website. PCAOB is the Public Company Accounting Oversight Board.
Edwin Dorsey (38:03): It’s a quasi-governmental agency that regulates auditors. And people don’t know this, you can type in any ticker and it pulls up what the auditor is and who the auditor has been for the last five years. That itself is actually somewhat common knowledge on Wall Street. You can find it very deep in the tech counter. Well, people have no idea what 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 have to just know
which auditor is auditing the company, you know which person is auditing the company. Edwin Dorsey (38:44): And what I’ve found is oftentimes, an auditor might have an okay reputation with 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 PCAOB website and see every company they’ve audited in the last four and a half years.
And if you see, wait, they audited six different companies, average share performance of like negative 90%, that’s a problem. If they’ve audited five companies that are sub $50 million companies and one company that’s a $5 billion company, wait, that’s a problem. Edwin Dorsey (39:17): What I think happens is every auditor, big four, not big four or whatever, will have some people who are just ready to be disposed of, ready to be the fall guy if something goes wrong and they’re assigned to all the questionable audits. Can I give you an example, Trey? Trey Lockerbie (39:32): Absolutely.
Edwin Dorsey (39:33): I want to go to the PCAOB website right now. It’s pcaobus.org. At the top, there’s a search button, and then you go auditor search. And there was a Chinese online education company, RYB Education that collapsed right after its IPO. So if you look
up RYB, and you can see in 2019, 2018, and ’17, the auditor was Deloitte Touche China. And the specific audit partner responsible for that audit is Li Li 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. Edwin Dorsey (40:08): One was RYB Education, which fell like 80%. One was Puxin, which is another online education company, which fell significantly. And the last one was GSX Techedu, which is this other online education company that collapsed like 90%. If you were researching GSX or these other companies, you pull her up and wait, the other two companies she’s audited 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, where specific audit partners only audit companies that fall 90% or more. It’s just fascinating. Edwin Dorsey (40:46): I think it’s because auditors know, wait, this company is a little sketchy so we’re going to sign our fall guy person to it.
And it’s just terrible, but that’s how it works, and not enough people are talking about it. And the crazy thing is smart to hedge funds don’t know about it too. So there are all these cool niche government websites that no one’s using enough, but all your listeners should use. Trey Lockerbie (41:08): What you’re touching on there are causation and correlation. So you’re correlating these auditors. And by the way, are they listed here as auditors? I’m also seeing an engagement partner? Edwin Dorsey (41:19): Exactly. That’s the specific person responsible. Trey Lockerbie (41:24): So, you’re correlating 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?
Edwin Dorsey (41:44): Yeah, precisely. This is precisely it. So it’s not like, “Oh, they have bad audit partners so their customers are going to be upset.” No, no, no. It’s that company is almost self-select and get it like, “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 pushed for it, and that’s a big red flag. And it just happens across the board. I’m literally looking into one
company now, I don’t want to say its name, a $25 billion entity. The audit partner has audited three companies that have fell 90% penny stocks and one $25 billion company. Edwin Dorsey (42:22): And it’s like, how is a $25 billion company getting that done? Well, it’s because they want somebody who’s going to sign off on anything where they can pay huge fees. And that’s a lot of what I do. So you look at bad directors. Does a board member actually have that much effect on a company? Probably not. But 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 questions. Edwin Dorsey (42:57): 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 like my prison
through the world where people have built 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.” Trey Lockerbie (43:17): We recently had Ben Mezrich on the show and he just wrote a book called The Antisocial Network. It was all about the GameStop saga with Reddit and WallStreetBets, 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 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? Edwin Dorsey (43:45): 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 if you’re wearing a suit and work at a big hedge fund, you probably think, “Oh, it’s all idiots living in basements staying to the moon, 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 predicted this all, it was remarkably well-researched. Edwin Dorsey (44:19): He was like, “Well, COVID is going to help with game sales if people stay at home more, and 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. That’s going to help GameStop. And they currently have a two-year one runway of cash. That will get them to a five-year runway of cash. And they’re at like one 10 sales. So six months from now, this business is going to go from nearly bankrupt 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.”
Edwin Dorsey (44:50): 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 this short squeeze, but it was just out there in the open, this great like A-plus quality work, and people still don’t recognize that. If you get this stuff to crowdsource, there’s a lot of nonsense, but there are diamonds in the rough there. So I think everybody should use it. Rather just type in the ticker and scroll through everything. And more often than not, there’s one useful thing. Trey Lockerbie (45:20): In the words of Charlie Munger, invert, always invert. So what I love about this approach is not so much that our listeners need
to go out there 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’re going through your basis. And then you cap it off with something
like this, almost as just another part of your checklist to ensure that you’ve covered your basis and there are not in other risks that you haven’t currently taken into account. Trey Lockerbie (45:57): 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? Edwin Dorsey (46:07): It depends, there are 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-Text Search tool, at least put the CEO’s name. Seeing who an audit partner is taken like
10 seconds. It also depends on the area you’re playing. As you’d expect, bigger companies tend to have fewer of these issues. I found once you get above the five 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 $1 billion area, these tools will add a lot of value.
Edwin Dorsey (46:46): 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 less of an issue. But for super small companies, any investor doing it,
I recommend it. 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, all your requests are almost market cap-independent, those can add value regardless of the size of the company. Trey Lockerbie (47:17): 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. 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 hand it off to our audience, where they can learn more about you, where they can fall along with what you’re doing. Anything else you want to share? Edwin Dorsey (47:40): Well, Trey, thank you. I had a lot of fun too. My Twitter handle is @stockjabber, Edwin Dorsey, @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 Bear Cave, 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. And so check out The Bear Cave newsletter if you’re into this stuff @stockjabber on Twitter, and keep listening to this podcast, because you guys do well too.
Trey Lockerbie (48:14): 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, Edwin. Let’s do it again sometime soon. Edwin Dorsey (48:23): Absolutely. Thank you, Trey. Trey Lockerbie (48:25): 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. 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 @treylockerbie. 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.
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