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 8^th 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., Nasdaq.com 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.