Monday, December 1, 2008

A Concern about Edelheit

In a previous post ("You pick the next post"), I mentioned I was thinking of writing a post about a concern I had about Aaron Edelheit's investment process. Perhaps that wasn't the best choice of words. I think Edelheit's general strategy of trying to buy obscure North American companies trading at single-digit multiples to his estimates of their forward earnings makes sense (although, as I've mentioned elsewhere, post-October there may be a better balance of risk versus reward in looking for currently profitable companies trading at low earnings multiples). Edelheit's track record is also impressive. The concern I have, which was prompted by a couple of his recent blog posts, is about whether Edelheit maintains an appropriate level of skepticism in his interactions with the management of the companies in which he invests.

ThinkEquity's 8th commandment of research (See the previous post for the other nine, "ThinkEquity's Ten Commandments of Research") is relevant here:

5 Independent Sources for Each Initiation of Coverage.

We will have regular dialogue with company management, but they will always see the glass as "half full."

One of the challenges of investing in micro-cap companies is that there are often few, if any, independent sources of information on the company, so an investor is more reliant on information supplied by the company itself (e.g., its SEC filings, conference calls, etc.). Because of that, it's important to maintain a level of skepticism when evaluating forward-looking statements by management. This is easier said than done, particularly after one has invested in a position: we all like to believe our initial thesis was right, and this can compromise our objectivity in evaluating information subsequently.

In fairness to Edelheit, he seems to limit his investments to companies where the managers put their money where their mouths are, by buying their own stock (e.g., shows that Destiny Media's insiders have been buying their company's stock over the last year).

These were the two posts that made me question Edelheit's level of skepticism, "Excellent Video on Car Bailouts", and "Adversity and Underprivilege". In the first post, Edelheit wrote approvingly of an appearance by New York Times columnist Tom Friedman on CNBC, and in the second post, Edelheit wrote approvingly of an essay by Malcolm Gladwell. Friedman and Gladwell are both highly-influential, best-selling writers, but they tend toward glib oversimplifications. A healthy level of skepticism is warranted when reading them. In his recent posts on Friedman and Gladwell, Edelheit's apparent credulity made me wonder if he has been similarly credulous in evaluating statements made by managers of the companies he owns. Of course, it's reasonable to assume that he is more rigorous in his vocation of investing than in his avocation of blogging, but since he is blogging eponymously, he may want to consider whether his recent posts may have raised the same concern in his clients or potential clients who read his blog.

For a skeptical take on Tom Friedman's commentary about the Detroit automakers, see my recent posts "Iraq, the Automakers, and the Limitations of Technology", and "Great Moments in Business Journalism". For a skeptical take on Malcolm Gladwell, see Michiko Kakutani's review of Gladwell's latest book, "Outliers", in the New York Times. Below is an excerpt from Kakutani's review.

Both [of Gladwell's two previous bestsellers, "The Tipping Point" and "Blink"] use PowerPoint-type catchphrases (like the “stickiness factor” and “the Rule of 150”) to plant concepts in the reader’s mind. And both project a sort of self-help chirpiness, which implies that they are giving the reader useful new insights into the workings of everyday life.

“Outliers,” Mr. Gladwell’s latest book, employs this same recipe, but does so in such a clumsy manner that it italicizes the weaknesses of his methodology. The book, which purports to explain the real reason some people — like Bill Gates and the Beatles — are successful, is peppy, brightly written and provocative in a buzzy sort of way. It is also glib, poorly reasoned and thoroughly unconvincing.


Albert said...

I voted meh this time because I think that it's far too much of a leap to say that based on an endorsement of a couple of things in a blog that AE may be too quick to believe what micro cap managers are telling him. If he had been overly critical in the two posts, would you have claimed that maybe he is far too cynical and should be more open minded in his investing?

The logical connection between the two points is just too tenuous I think.

DaveinHackensack said...

Fair enough, Albert. The connection is tenuous enough that I qualified my comments in this post, and hesitated for a week or so before writing it. I also didn't want to write this on Edelheit's own blog, which, he says, some of his clients read. I doubt any of them read my blog, so I posted my thoughts here.

JK said...

I don't really see anything indicative of gullibility based on those two blog posts either. I think its easy for an individual who doesn't agree with someone else on an issue to think the other side "isn't thinking hard enough or else they'd agree with me". While I'm not a fan of bestseller, self-help lite either, Gladwell for instance is an author who isn't writing for peer reviewed scientific journals, but for a mass consumer audience. If anything he writes intrigues you, then you look at the source material more in-depth and synthesize your own opinion. I don't really see how referencing these guys in his blog indicates a lack of rigorous thought processes.

Most any opinion material on a blog is "glib" and "oversimplified" as well, but that doesn't mean blogs aren't worth reading.

Having said that, I actually do agree with the overall thesis of this post. I get the same gut feeling (Gladwellian? lol) regarding his process, from reading what he writes. I also sympathize with the plight of trying to make a blog post about it, because that gut feeling I assume we share regarding his process is formed from an aggregate of otherwise trivial nuances that are pretty insignificant by themselves. But the impression that this blog post gives off is that you just don't agree with him on a couple peripheral political/social issues so you're questioning his whole mental process. In fairness to your thought process as an avid reader of your blog, I suspect there's more to it than that, but that's just how it reads to me.

DaveinHackensack said...


"I get the same gut feeling (Gladwellian? lol) regarding his process, from reading what he writes."

Just to be clear, are you referring to Edelheit's process or Gladwell's above?

"But the impression that this blog post gives off is that you just don't agree with him on a couple peripheral political/social issues so you're questioning his whole mental process."

That's unfortunate, because it wasn't my intent and I don't think that's the case. Regarding the Detroit situation, for example, from subsequent correspondence with Edelheit on his blog, it appears that our positions are fairly similar: both of us think that the automakers need to be reorganized in Chapter 11 to emerge as viable companies. My concern about Edelheit is just what I wrote in this post, the seeming credulity with which he accepted some simplistic punditry.

You're right though that a lot of folks don't put much rigor into their blogging (in fact, some of the most widely-read political bloggers, e.g., Andrew Sullivan and Matthew Yglesias, tend to shoot from the hip most of the time), so there may be little connection between how Edelheit thinks about an op/ed column and how he thinks about a prospective investment.

Maybe I'm just a little taken aback by someone who seems to be fairly devoid of cynicism.

JK said...

"Just to be clear, are you referring to Edelheit's process or Gladwell's above?"

Edelheit's process. "Gladwellian" was a reference to Gladwell's written work on gut reactions.

"Maybe I'm just a little taken aback by someone who seems to be fairly devoid of cynicism."

Agree here. Feel good fluff is not my style either. I just think if a case is going to be made against his investment process, then the case should use examples from his writings on investments to be effective. That's all.