FOOL ON THE HILL
An Investment Opinion
by Louis Corrigan
The Egghead and the Trader
Shares of Egghead.com, Inc. (Nasdaq:EGGS - news) have more than doubled since July 6 when the PC software and hardware vendor announced preliminary first quarter results that suggested it might have made a smart move in ditching its brick and mortar stores for a purely online business. Its Surplus Auction website, for instance, saw revenues jump to $13.7 million from $7 million in the December quarter. Many serious investors thought it was about time the Internet euphoria caught up with Egghead given that the company's has a well-known national brand and a solid balance sheet, two things many flash-in-the-pan "e-tailers" lack. Thus, it wasn't a total surprise to see the shares break to a new 52-week high on the news, up 65% for the day to $14 13/16.
Opportunistic traders look for such situations. And Louis Riley seems to fit that bill. A frequent contributor to the Shark Attack message boards on America Online (NYSE:AOL - news) , Riley is also one of the traders behind the Stock Investor Trading News (http://www.sitn.com) as well as the principal of Riley Capital Research based in Houston, Texas. Writing under the SITN banner, Riley helped fuel K-tel's liftoff by issuing a "strong buy" rating on the stock in mid-April. Calling the firm "extremely undervalued" relative to other online music retailers such as CDNow (Nasdaq:CDNW - news) and N2K (Nasdaq:NTKI - news) , Riley suggested the stock could easily trade over $50 in the short term. It was then selling for just $10 5/8. (All prices are split-adjusted.)
K-tel did make it to $39 1/2 before plunging -- it closed at $11 1/2 today. Though you won't find a "sell" recommendation from SITN on the PRNewswire, Riley and his associates apparently exited the stock long ago. What you will find is a May 14 report from Riley Capital starting Advanced Health (Nasdaq:ADVH - news) , then trading at around $13, with a "strong buy" rating and an initial price target of $37. That stock enjoyed a brief blip to $16 and then another little bounce a few weeks later when Business Week's "Inside Wall Street" column featured Riley's recommendation. Since then, the stock has suffered from advanced sickness, falling below $4 a share. But you won't find any follow-up press release from Riley on that one either.
What you will find is another press release dated July 9 in which Riley Capital initiates coverage of Egghead.com with a "strong buy" rating and 12-month price target of $85. Riley's rating was widely reported in the business press and helped reignite enthusiasm for Egghead shares, which rose as high as $29 1/8 on Monday before slipping back to $20 11/16 today.
You can also find an interesting July 6 post on the Shark Attack message boards in which Riley says Egghead's news will finally "really move" the stock and that he's bet heavily on a rally. "I am long the common to the gills and that is my 100 contract print @ 11/16 on the July 15 calls." That meant that in addition to buying the stock, Riley paid $6,875 for options that could make him a fortune if the stock rose significantly. "If tulipmania runs for a while, I guess it should print $30 by expiry," he said. And Riley was already thinking aloud about his gameplan. "Hmm, maybe I should issue a press release to make up for ADVH anyway? Nahh, that would be wrong."
It's unclear why he thought that would be "wrong," but he clearly changed his mind. It might have had something to do with the fact that the Egghead rally was stalling, with the stock dropping to as low as $13 3/4 on July 8. Without another leg up, Riley's call options would expire worthless.
While the press releases from SITN and Riley Capital have clearly stated that the analysts and their affiliates have put their money where their mouth is, Riley isn't exactly forthcoming about the fact that he doesn't necessarily believe his own arguments. He talks fundamental analysis and increased Wall Street coverage in his Egghead report, somehow failing to mention the benefits of "tulipmania," which appear to be of overriding importance.
The two SITN press releases on K-tel also turn repeatedly to the relative valuation of this upstart e-tailer. Judging by countless message board posts, many individual investors found Riley's arguments compelling. So it's surprising that in a June 19 e-mail to a Fool staff writer, Riley argued that the psychology of crowds, not fundamental analysis, was the only way to explain such tulips. Moreover, he said his relative valuation argument comparing K-tel to CDNow and N2K was "perhaps admittedly disingenous" [sic], but little different from the kind of positive comments made by presumably respectable sell-side analysts.
Riley didn't respond to an e-mail seeking comment on these matters. In fact, he's never responded to any of my attempts to talk with him, but I think it's easy to see where he's coming from. The guy is a trader looking to make money any way he can. He's smart enough to know how companies should be valued, but he's more interested in stocks than in companies. That means he will gladly "play" a mania for a fast profit if he thinks he can. Though he's fond of calling just about anyone he doesn't like a hypocrite, he also doesn't mind publicly spouting intelligent-sounding nonsense that he doesn't believe if it will help his positions.
I don't like what Riley does, but he has a perfect right to do it. He's been forthcoming about his financial interests. Moreover, those who understand his approach have probably made some good money following his lead. And if some investors believe the arguments that he seems to know are dubious, is he any more to blame than those gullible investors themselves? Also, his cynicism about Wall Street is partially justified. Many big brokerage house research analysts are compensated based on the investing banking work they help attract, so they have a clear financial incentive to say good things about companies that they privately may have serious questions about.
Yet, the fact remains that the Internet allows a public platform for folks who might otherwise never merit one. And anybody can pay $100 for an annual membership to the PRNewswire and pretty much talk up any stock he or she wants. Consider the Woodward Trading Company, which on May 27 issued a "strong buy" report with a 12-month price target of $30 on Saf T Lok (Nasdaq:LOCK - news) , a small company that makes gun safety locks. That stock jumped from $3 3/4 to $6 on the recommendation, which noted that "Saf T Lok may have as much monopolistic potential as Microsoft (Nasdaq:MSFT - news) did when it first started out."
Turns out this Atlanta-based securities firm consists mainly of Craig H. Woodward, who was at the time a registered representative with American Wealth Management, Inc., an Atlanta firm that processes trades for 21 independent brokers. According to a Wall Street Journal report, American Wealth's president Jerome Borzello immediately ended this arrangement with Woodward after the press release was issued. Also, it seems that Woodward did have a position in Saf T Lock at the time, though that fact isn't mentioned in the buy report. The Woodward recommendation coincided with a number of other funky activities at Saf T Lock, which shortly thereafter fired its CEO. Company founder and Chair Frank Brooks said he had never heard of Woodward before the press release, though Woodward assured him in a phone conversation days later that he was a long-term investor and hadn't tried to hype the stock for a quick profit. But who knows? The stock is back again at $3.
Investors must realize that analysts at respectable Wall Street firms usually don't make their research reports available to the general public. So reports sent out on the wire services are likely there for a reason, either to move a stock to make the "analyst" money or, at the very least, to create some publicity for that analyst or perhaps for the public company itself. The bottom line is that investors shouldn't believe the purported facts much less the opinion in any stock research report, message board post, or news article without checking those facts and evaluating the arguments independently. If you lose money because you haven't done your own due diligence, then unfortunately, you've really got no one but yourself to blame. |
