Update on VBDG

In a post in March ("Applying the Altman Z-Score Model to a Non-Manufacturing Company"), I mentioned a company called Vertical Branding (at the time it was on the OTC BB; now it's on the Pink Sheets: VBDG.PK). I noted at the time that the Altman Z-Score model predicted bankruptcy for the firm and that when I had shared this information with the folks on the Investor Hub message board for the stock, I had gotten the Enemy of the People treatment. Since then, in addition to getting kicked to the Pink Sheets for not filing its financial statements, the stock has dropped 50%.

A few days after that March post I was indefinitely banned from Investor Hub's VBDG message board. The moderator who banned me was the plaid-shirted fellow holding the fish in the photo below (the photo comes from his moderator profile on Investors Hub).

Update: I didn't note this at the time, but this fellow happens to be Matt Brown, the lead site administrator of Investors Hub, who was recently indicted on criminal securities fraud charges, and remains free on a $50,000 bond posted by his father.



This illustrates one challenge in managing stock message boards. You need some form of moderation to minimize spam and other comments that detract from a board, but when you give the authority to moderate to an individual, such as the fellow pictured above, you are forced to rely on his assessments, and if your moderator's assessments aren't objective¹, you risk losing informative posts. I believe there is a better way to moderate stock message boards, but that will be a subject of a future post.

¹E.g., perhaps he is long the stock and is biased against bearish posts?

A Stock-Promoting Prodigy

Hat tip to reader J.K. for this news item about civil and criminal charges brought against the alleged perpetrators of a cross-country pump & dump stock racket. One of the accused is Matthew Brown, who operates a stock message board site we've mentioned here before, Investor Hub.

J.K.'s mention of that news reminded me of an excellent New York Times Magazine article from 2001, written by Michael Lewis, about high school student who made a small fortune promoting stocks during the dot-com boom: "Jonathan Lebed's Extracurricular Activities". Jonathan Lebed made close to a million dollars buying stocks, pumping them on Internet message boards, and then selling after driving up their prices. This eventually drew the wrath of the SEC. One of the best parts of Michael Lewis's article is when he tries to pin the SEC down on what, exactly, made Lebed's stock promotion different from that of Wall Street's. This scene, which we'll enter in medias res, starts on page 8 of Lewis's article:

''Richard -- call Richard!'' [then-SEC Chairman Arthur] Levitt was shouting out the door of his vast office. ''Tell Richard to come in here!''

Richard was Richard Walker, the S.E.C.'s director of enforcement. He entered with a smile, but mislaid it before he even sat down. His mind went from a standing start to deeply distressed inside of 10 seconds. ''This kid was making predictions about the prices of stocks,'' he said testily. ''He had no basis for making these predictions.'' Before I could tell him that sounds a lot like what happens every day on Wall Street, he said, ''And don't tell me that's standard practice on Wall Street,'' so I didn't. But it is. It is still O.K. for the analysts to lowball their estimates of corporate earnings and plug the stocks of the companies they take public so that they remain in the good graces of those companies. The S.E.C. would protest that the analysts don't actually own the stocks they plug, but that is a distinction without a difference: they profit mightily and directly from its rise.

''Jonathan Lebed was seeking to manipulate the market,'' said Walker.

But that only begs the question. If Wall Street analysts and fund managers and corporate C.E.O.'s who appear on CNBC and CNNfn to plug stocks are not guilty of seeking to manipulate the market, what on earth does it mean to manipulate the market?

[...]

I finally came clean with a thought: the S.E.C. let Jonathan Lebed walk away with 500 grand in his pocket because it feared that if it didn't, it would wind up in court and it would lose.

[...]

I might as well have strolled into the office of the drug czar and lit up a joint.

''The kid himself said he set out to manipulate the market,'' Walker virtually shrieked. But, of course, that is not all the kid said. The kid said everybody in the market was out to manipulate the market.

''Then why did you let him keep 500 grand of his profits?'' I asked.

''We determined that those profits were different from the profits he made on the 11 trades we defined as illegal,'' he said.

Lewis goes on to underline the tautologies.

J.K. noted that Jonathan Lebed is still in the stock promotion business. Here is his site.

The photo above, of Jonathan Lebed, is the cover of the New York Times Magazine issue in which Lewis's article on Lebed was published. For some reason, the New York Times doesn't include the photos that accompanied its older articles in its online archive, so I got that image from Williamgaddis.org. For those too old or young to catch the allusion, the photo's caption is a play on the title of a short-lived cult TV drama from the mid-1990s called My So-Called Life.

Applying the Altman Z"-Score Model to a Non-Manufacturing Company

Tools and ideas for short sellers, including an automated calculator and screener based on the Altman models.

In a previous post ("Using the Altman Z-Score to Calculate the Risk of a Company Going Bankrupt") I used Altman's original model on a publicly-traded manufacturing company. On Tuesday I used the Altman Z-Score model on a publicly-traded (micro cap) non-manufacturing firm, Vertical Branding, Inc. (OTC BB: VBDG.OB), the marketer of such fine products as the "MyPlace Cozy" lap table, pictured above. I had seen this company mentioned as top pick by a few regulars on the Investor Hub website. Initially, I used the original Altman Z-Score model -- which was designed for manufacturers -- on Vertical Branding. Recall from our previous post on the subject, that the original Altman Z-Score model uses these five terms:

T₁ = Working Capital / Total Assets
T₂ = Retained Earnings / Total Assets
T₃ = Earnings Before Interest and Taxes / Total Assets
T₄ = Market Value of Equity / Total Liabilities
T₅ = Sales / Total Assets

And weights them this way:

Z Score Bankruptcy Model:

Z = 1.2T₁ + 1.4T₂ + 3.3T₃ + .6T₄ + 1T₅

Using an online calculator based on the original Altman Z-Score model, I got a score in the "distress" zone, one that indicated that bankruptcy was likely within two years¹. I mentioned this on Vertical Branding's Investor's Hub message board. Unsurprisingly, I got the penny-ante version of the Enemy of the People treatment for my trouble. I did get one legitimate criticism though, that I had used the Altman Z-score formula designed for manufacturers. So I ran the numbers again using Ironwood Advisory's online calculator, which gives the option of selecting for non-manufacturing companies. That option uses the modified Altman Z"-score model, which uses only the first four terms used in the original multivariate formula, and eliminates the fifth variable, sales/total assets, because this variable varies widely among non-manufacturing firms, which tend to be less capital-intensive. The Altman Z"-score model weights the first four variables differently:

Modified Altman Z"-Score Bankruptcy Model:

Z = 6.56T₁ + 3.26T₂ + 6.72T₃ + 1.05₄

Using the calculator set for non-manufacturing companies produced an even worse Z-score than the original model did. This was consistent with Penn State Accounting Professor Gregory Eidleman's observation that the original Altman Z-score model can under-predict bankruptcy of non-manufacturing companies. After correcting an apparent data-entry error on my part, I got an Altman Z"-score of -4.30 for VBDG. For non-manufacturing firms, any score below 1.1 is an indication that the firm is at risk of bankruptcy within two years.

Coincidentally, on Thursday morning Vertical Branding filed an 8-K noting that it was in continuing negotiations to restructure its debt and that the company's board of directors had authorized its management to

[E]valuate and pursue all strategic opportunities available to the Company, including the potential sale of the Company.

On this news, VBDG dropped 31%.

¹This makes intuitive sense, if you look at the company's income statements and balance sheet: the company has negative earnings before interest and taxes (EBIT), negative retained earnings, and negative working capital; essentially, it's a money-losing, debt-laden company.

Another Alloy Steel Post

In a post a couple of weeks ago ("Alloy Steel Update"), we quoted an e-mail from the CFO of Alloy Steel (OTC BB: AYSI.OB) in which he intimated that the company might file an 8-k or issue a press release about its fiscal fourth quarter results within the next week. At this point, since there's been no announcement from the company, it's likely we won't hear anything until Alloy Steel files its 10-k later this month. Alloy Steel's lack of emphasis on shareholder communication isn't new; the company still hasn't set up the investor relations section of its website. If you click on one of the tabs under the "Investors" heading on Alloy Steel's website, your taken to a generic page on the website of the company's outsourced IR web vendor (the stock image above is from that generic page.

In a discussion about Alloy Steel on its Investors Hub message board , I mentioned that I was less concerned about the previous quarter's results (which I think will be positive) than I was for the company's prospects in '09, given the global recession and the grim news from the mining industry. A commenter who goes by the handle "Littlefish¹" explained why he was confident in the company's prospects during this downturn. Below is his explanation.

I have a lot of confidence in the company being around when things recover, excepting some kind of huge technological breakthrough in wear plates that puts all alloy wear plate into permanent obsolescence.

I don't have confidence in when they'll get around to putting out prelim or audited results though:) Except probably by the end of year. Hopefully much sooner but who knows. I don't want my eyes permanently crossed so am only going to cross them for one night.

If you look at the company's operating history, it is vanilla plain clear to see they know how to weather tough times. They survived years (especially 2001-2003 tough times) on practically nothing (IMO).

Unlike many micros out there, I would say the likelihood of them making it thru the next year readying themselves for a hopeful recovery at SOME point is extremely likely.

They've been thru this before with the Aussie miners. Plus now they have a little bit of chance to get themselves into new markets. They haven't borrowed from any banks. They have no dilutive instruments. They got thru 2001-2003 w/o diluting or borrowing from lenders.

And they have mostly paid for the 2nd mill already with internally generated cash. Worst case, knowing Gene's fiscal responsibility, they could just operate one mill until a 2nd is needed and adjust headcount to keep pace with what they have for work.

What is the WORST operating earnings loss they have reported in their operating history? One thing seems pretty clear with about 8 years of filing as a public company, they don't lose much money regardless of economic conditions and sales. And have tight cash flow management.

Plus without debt and with prior history of having opertaing income even on $500K revs Qs (I think even $400K Qs if I recall), I just don't think we'll see them evaporate. The cash they have IMO they will hold or spend judiciously. If they spend it, hopefully it is to finish off the 2nd mill and/or branch out to sales in US etc.

As ambu [another I-Hub commenter] mentions, they've probably missed out on some revs growth during this last commodity bonanza go-round by being so cautious. But it also means they should be fine in this downturn.

I think this company will be in a better position than before IF/WHEN we get a recovery (because of capacity upside, cash on hand for a change).

BUT when is that recovery? Who knows.

What would be a strong endorsement to the product quality and potential IMO is to see sales actually grow in this mining industry/commodity blowup. It won't be easy but one avenue to seeing that happen would be by tapping into markets they don't sell into much now (like the US).

As I mentioned in a previous post (Vaalco Energy Update), I sold a few shares of Vaalco to free up some cash to buy some more Alloy Steel. My limit buy orders for Alloy Steel haven't been filled yet though.

¹"Littlefish" was the subject of a pair of posts here over the summer about his success with another micro cap stock, Mexco Energy: "How One Investor Found a Home Run Stock, Part I", and "... Part II".

How One Investor Found a Home Run Stock, Part III

Below is Littlefish's addendum to his recollection of how he found Mexco Energy (MXC):

LOL, the fun part was after doing some DD on it after that time period. I do recall early on I felt pretty good about the initial wave of DD and started whooping it up in the study room when I knew I ahd something good (kinda felt like AYSI but I wasn't real confident on the Tarrant Cty wells yet).

My wife wondered what was up when I had all the commotion going on. It was weird though, I felt rather sure it was an easy 50% gainer and told my wife so. I also told her it would take some patience or a little luck to get a lot.

So I waited for I think several weeks on the bid and attacking the ask whenever more than a few shares came up available. I built a moderate position but never got the big fat chunk I wanted cuz it never sold down and the volume was mostly anemic.

There were I think 3 times though where the MMs or someone traded thousands of shares BETWEEN the bid and ask (maybe $4.2-$4.35) and I was away from the computer each time AND was on the friggin' bid EACH TIME as I recall (the trades happened over maybe 3-5 minutes' time each and seemed to happen around 8-10:30 AM Pacific on difft days with the trades mostly 1 penny above the bid and one penny under the ask so kinda weird).

After it happened the first time, I made sure the next day I sat vigilantly in front of the screen during that time.

But it was a waste of time after a couple days and had other stuff to do so sure enough a few days later it happened that 2nd time. When I went in and saw the volume I felt like swearing LOL. I was pissed that someone was getting a few thou shares in a few minutes when I was getting that many over maybe a week or so on a light week. So I would up the bid and sit all day getting maybe 200-500 shares. Sometimes.

Whenever I'd see a retail investor put in an order at the ask, say maybe 500 or 1,200 shares I grabbed fast. When my position was OK, I got my daughter in on the act chanting "Let's Go Mexco" when it went up. Man, we were dancing around a lot for a little while there LOL. She's 5 years old.

After getting my position about half full I mentioned it on I-Hub. Then waited thinking some people would start getting in. But no one did. I even posted on the VMC board 'hey guys I see 1,000 shares (or whatever it was) that have been sitting on the ask for the last hour or so (I htink it was around $4.5 or so), anyone want them?' or that was the gist of my post. No one grabbed them for awhile. So then I ate them up myself before the day ended.

Then after awhile with time it rather suddenly broke out to the upside so I sold a little. Then it pulled back a bit os I grabbed them back cuz I still ahd less than the position I wanted.
Then somewhere in there a PR announced the flow rates on the other 2 wells and I went ape sh#% when KiK posted the PR. I immediately started buying again and even drove it up a little.

Then eventually the whole market fell in love with micro energy plays and the thing took off way above anything I (or probably anyone) thought it would do. It was fun but way excesive

Anyhow, I got work to do now.

Oh ya, It;'s

'A NEW HIGH FOR AYSI!" in the house now:) Although haven't been able to pull that one out as much as the Mexco slogan...

How One Investor Found a Home Run Stock, Part II

Littlefish's explanation of how he found out about Mexco Energy (Amex: MXC) continues below:

I've been writing this piece meal over the last 2 1/2 hrs of work as time permits so it may be disjointe das hell so sorry for that.
but anyhow, I then saw MXC had been in a heavy downturn for awhile (2-3 years) and had recently purchased their largest nat gas production interest. Volume was anemic and the sellers had been washed strongly out (kinda like GV now but GV needs to get clsoer to a turnaround in---dare I say it--- the Fla condo market).

Yet the stock hadn't responded so then I looked over reserves and production and saw that both those had also started increasing. Then I went digging around trying to find out about their drillings and what areas they were working on, where their acreage was, etc. A couple drillings were taking awhile so I called the CFO and asked for clarification as to what kinds of things might be delaying those coming online. I also wanted to find out what I could about the new purchases since they were a bit of mystery. I came to find out the CFO didn't know specifics either on the wells so I tired to find out on my own. I got production for one of the supposed 3 wells. But it had been in production for over a year and ahd a fairly steep decline curve (so I wouldn't be too excited owning MXC after another Q report or two since the other wells may decline too but also found otu it is a pool of wells and not the original 3 wells announced last I heard- they never did clarify that).

I had no idea about the other 2 wells and their potential until a PR came out about the flow rates in a PR. When that hit I bought even more (some of which I had recently sold because it had popped)...

OK enough LOL. I'm boring everyone in AYSI land.

But in retrospect it was nice to see that last Q rpeort to verify my thinking that they could probably set alltime records for earnings and revs (they did for both). What surprised me was the lack of interest in the company all along until suddenyl it went crazy.

Then specualtion took over, record earnings, the microcap energy sector went ape crazy, low float, it got added to the Russell, etc... And I only own 200 shares now LOL. It was a bigger chunk of my port than AYSI for a little while there.

It was total luck to get that return in that timeframe obviously. But seeing earnings confirm my thinking makes me feel better regardless of share price.
Plus the CEO is a bit of tightwad IMO and owns over 50% of the company (ahem, not that any other CEO out there would be that way- although for the record AYSI's website kicks azz compared to what used to be MXC's so MXC won the worst website award from me so I gave MXC a slightly higher point value score on web ugliness in my evaluation- although MXC redid their website recently so now it is all pretty and bling).

MXC and AYSI are the only 2 companies I've ever owned/controlled where my position was 1% of the company or more. But they are also the only 2 companies I can think of that have fiscally tight leaders that own over 50% of the company and bright prospects in their biz segments and are microcaps with near (or at) zero dilution.

That's my elongated, disjointed, semi-accurate recount (I think) of what I think is the general idea of how I went about refinding MXC.

Littlefish added an addendum to this which I'll post in Part III.