Market Summary
MARKET
Shares issued 0
1899-12-30 close $0
Friday Feb 23 1990
Daily Market Report
In last Monday's market summary we reprinted exerpts from the first part of John
Kaiser's philosophical talk about how to pick stocks on the VSE - "longshots", as
he calls them. We got as far as his thoughts on the company's background. This
week, we will carry on and cover the company's structure, its people, its story and
its capital.
The structure section contains the most important information about the longshot.
It consists of a record of prior share issuances including date, quantity, price and
type. Ideally it also includes to whom the shares were issued, though this data is
only occasionally relevant and available. The lower the price the better, because
it means insiders have been positioned, and the stock has developed an incentive
structure. Remember, for a speculative stock to go anywhere, someone must
care about its future. Who has more incentive to care than an insider group
positioned to profit substantially from a price increase? And before someone
starts worrying about how unfair it might be that insiders build up cheap
positions well before the public even begins to think about owning any shares,
consider that the stock likely has nothing going for it at the time, and never will
unless someone has incentive to work hard at getting a story for the company
and making a reality out of it.
When studying the structure of a longshot, an investor must also study the
corresponding market behaviour depicted in the chart (see last week).
Price-volume triangles typically materialize a year or so after low priced share
issuances such as private placements. The reason is simple: placees are
restricted from selling their shares for a one year period from the date the funds
were advanced. Unless insiders already hold free trading shares, not much
market activity will happen until a year later. Also, it takes time to put a story in
place and develop it to the point where it could be expected to excite outsiders.
Private placements can give longshot players a good idea about the timing of a
stock's future move. In constrast, high priced issuances tend to occur during the
higher altitudes of the triangles, a result of popular demand. To do their job well,
insiders have to be contrarians. They buy on low volume and sell on high
volume. Longshot players do the same, taking their cue from the insiders'
activities. (Note: longshots are chosen on the basis of publicly available
information. Also, the use of the word "insider" is not intended to convey the
pejorative meaning that has arisen through well-publicized insider-trading
scandals.)
The life cycle of a stock is closely linked to the distribution cycle, which reflects
the changing share ownership relationship between insiders and outsiders. A
good analogy is water and its physical states of ice, liquid and gas, which change
under the influence of temperature and pressure. The normal sequence is
freezing, thawing and vapourizing, though as anyone familiar with physics knows,
water can switch between solid, liquid and gas in any order under the right
conditions. The structure of a speculative stock tends to go through a phase of
crystallization as insiders acquire positions and liquidity dries up (usually before a
story has been unveiled), then a melting phase as the insiders create some
liquidity by selling shares as the story begins, and finally the evaporation phase as
the story is brought to a boil and the shares are dispersed in all directions. At the
end of each life cycle ownership ends up widely distributed, with the majority of
shares held by outsiders. If the story fails and the price declines, these
shareholders lose and the insiders are cursed; if it succeeds and the company is
taken over by a senior corporation, which provides liquidity for everyone
through an offer of cash or a highly liquid senior security, everyone ends up a
winner and the insiders are hailed as heroes.
When the structure is crystalline, someone has strong incentive to make the
stock perform in the future. The poor liquidity implied by a crystalline structure
will also make the stock very volatile once the promotion begins, yielding big
percentage gains to longshot players. The drawback is that it is difficult for
outsiders to accumulate substantial positions. For this reason a partially melted
structure may be more attractive to speculators who like to place bigger bets.
What is important is that the insiders have worthwhile positions, either as
leftovers from a previous life cycle or as a result of restructuring done during the
current life cycle. Except in rare instances where good fundamentals erupt out of
nowhere, a stock where insiders have minimal positions is not going to go
anywhere. The answer to the question, "will the company go anywhere in the
future?", depends on the share positions held by insiders. How fast and high
depends on liquidity. No investor should dabble in speculative stocks without
having a basic understanding of liquidity and the dynamics of supply and
demand.
The people section identifies the insiders, which includes management and
significant shareholders. Their share positions are also revealed if available.
Knowing who the people are behind a speculative stock is essential. Their track
record reveals whether they will attempt and may succeed at doing something
big with the company.
Management of speculative companies falls into two broad categories: the
administrative types who organize companies as public vehicles, and those who
try to do something with the company.
Corporate administrators are the people who know the rules about setting up a
company. They recycle dormant listings, reorganizing and selling them to people
who are too busy to fiddle with the details of creating a public vehicle from
scratch. There are good and bad corporate administrators. They will usually
have a long list of public companies associated with their names. They cannot
take credit or blame for the performance record of these companies, but this
"track record" does reveal how well they do the structuring job and the sort of
promoters their shells attract. As a rule, corporate administrators will not try to
do anything with a company and could not, even if they tried. Their track record,
however points to people who might. Experienced administrators know what
they are doing and do it right. Very often they provide vehicles to the same
promoter groups. Shells in the hands of amateur or incompetent administrators
are to be avoided as longshot candidates.
Those who try to do something with a company are measured by a different
yardstick. These are the people who will make or break a company. Their track
record is consequently very imnportant. A company with all the pieces in place
except good people is not going to go anywhere, either as a speculative market
play or a fundamental success story. On the other hand, if an experienced group
slips into the driver's seat of a "gaseous" company structure, capital and story
will eventually fall into place. Going with the prople has always been a maxim in
the speculative brokerage business.
The people behind a speculative stock must be evaluated according to four
criteria: organizational, technical, promotional and financial talent. The organizer
runs the company, negotiates deals, coordinates the company's activities, and
keeps the story in focus. The technician understands the story and works on
developing its fundamentals. These are the industry experts, which include
engineers geologists, product developers and other specialists. Unlike the
organizer, the technician often lacks the broad perspective needed to guide the
company. The promoter tells the story to the public, using a distribution network
to bring the buying that generates liquidity for existing shareholders. The
promoter's role, often maligned, is crucial. Without publicity, nothing happens to
a stock in terms of market activity. He is the expert on human emotions, who
times and designs the public relations campaign. The financier uses the liquidity
generated or promised by the promoter to raise capital from private investors or
members of the public. A financier's track record is his key to attracting funds.
Without capital a speculative company can neither tell its story nor make it
happen. The extent to which the insider group possesses organizational,
technical, promotional and financial skills determines whether the company can
go somewhere.
The capital section reveals the longshot's financial condition, its future funding
needs, and the capacity to meet them. If a company has no active and plausible
story, and has a substantial working capital deficiency, it is not worth a second
thought as a longshot candidate. The only exception would be if the debts are
owed to insiders, who will have little choice but to settle the debt for shares,
usually deemed at the minimum permissible price of $0.15. Such an event is a
sign that restructuring is underway and that the stock is being groomed for a new
life cycle. It is preferable to wait until a debt settlement has occurred.
Sometimes a company has a working capital deficiency incurred throught
development of a story that is still very much alive. Management will find itself in
a very trick spot, especially if upcoming cash calls threaten forfeiture of the
story. The closer the cash call, the uneasier the street becomes, wondering if the
reason no one has jumped to finance the story is that something is seriously
wrong with the deal. The financial squeeze can, however, attract well-heeled
groups, who will often give the stock a powerful push once a deal is struck with
the beleaguered management. Companies in this predicament should only be
chosen as longshots if their story is so good the arrival of a white knight is
virtually assured.
Occasionally one stumbles across cash-rich companies with no interesting story
and trading near their cash liquidation value. Large working capital positions
were usually raised during an earlier story that subsequently collapsed before the
money was spent. Insiders commonly react in one of two ways to this situation,
depending on how many shares they still own. If the structure is gaseous, the
money usually disappears, either through advances to acquisition targets or the
payment of an acquired company's liabilities. Sometimes the money is loaned to
other companies related to management. In most cases the stock's price goes
down and down until the financials register zero working capital. Then the stock
gets suspended or recycled. Where structure has a poor rating but working
capital is high, the company is only a longshot candidate if management has an
impeccable track record of integrity.
The other common response to cash rich treasuries is to treat the remaining
working capital with absolute caution. Stung by the failure of the story on which
the money was raised, these insiders will be determined not to waste the money.
They carefully hoard the money, spending it ever so slowly in search of the
perfect story. Nothing happens to the stock for years, and one day, lo and
behold, the money is gone. Nevertheless, someimes the insiders do come across
a great story, and because the money to develop its fundamentals is already
there, the story can begin immediately.
The best capital rating for a longshot occurs when a company is adequately
funded to meet its short term needs, and has people on board who have a track
record of raising sizable funds for good stories. Since insiders tend to be averse
to dilution, they will try to raise the larger funds at much higher prices. The need
to keep developing the story's fundamentals makes higher prices almost a
necessity. Every story strives toward a rewarding outcome. How it gets there
will always include the question of funding.
The story section either declares that there is none and speculates on what might
be waiting in the wings, or it tries to articulate the type, nature, scope, plausibility
and timing of the story which is already the object of the company's current life
cycle. The use of the word "story" may be puzzling or even offensive to some
people. It comes from the observation that investing in speculative stocks
resembles the act of reading a story. Reading a story is a series of anticipations
and revelations, full of surprises and gratifications depending on the twists and
turns of the plot. The text guides the reader's expectations, building them up as
the conflict is unveiled and developed. The plot culminates in a climax where the
conflict is resolved, sometimes as expected and hoped, other times not.
Investing in speculative stocks is not much different. By comprehending a story's
plot, the investor can predict the audience's reactions.
Getting a feel for the timing of a story's fundamental developments requires an
understanding of the story's nature. What is the "conflict" around which the story
revolves? Does the profitability of a story pose a functional, organizational,
production or marketing problem? A functional problem would be a better
mousetrap. An organizational problem would include service industry projects
and franchising operations. A production problem would include mine
development projects. And marketing problems would include products that
prople have lived without and could go on living without. Some stoies have
combined problems. Understanding the story's "problems" will make it easier to
assess the timing of key milestones in the development of the story's
fundamentals.
An important principle longshot players must understand is that the story as told
and as it happens are not in phase most of the time. Promoters are prophets
who predict a company's fundamental developments. Speculators buy the shares
because they expect the prophecies to come true. The result is that prices often
leap far ahead of the realities. But if reality were only to catch up with the
expectations implied by prevailing prices, the story would be a failure in the eyes
of the speculators. The speculators are expecting the story to grow even bigger,
the fundamentals to evolve beyond the prophecies. It would never do if a
company trading at $5 per share with a market value of $100 million but a book
value of $1 million or $0.05 per share actually became worth $100 million. By
that time the company better be looking like it's going to become a billion dollar
company, or the speculators will have abandoned the stock a long time ago.
Speculators want big wins, not reasonably assured rates of return. Lurking in the
back of every speculator's mind is the expectation that even greater optimists
will be attracted to the stock.
Next week will be the completion of John Kaiser's longshot theories. He will talk
about the two types of story, the experiment and the project, and how to assess
each one.
(c) Copyright 1990 Canjex Publishing Ltd.
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