Review: The Sleuth Investor, by Avner Mandelman

The Sleuth Investor: Uncover the Best Stocks Before They Make Their Move, by Avner Mandelman. New York: McGraw-Hill, 2007. 224 pp. $24.95 (hardcover).

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Many books on investing begin with complex instructions for analyzing a stock’s fundamentals or the blips that its price makes on a screen. Avner Mandelman, however, begins The Sleuth Investor: Uncover the Best Stocks Before They Make Their Move by simply describing what a company is and is not.

A company is not its legal charter, nor its annual report, nor its corporate filings . . . nor is it a string of historical prices that can be plotted together and regressed. Rather, a company is a group of people doing work in an office or a plant, so that other people (the customers) will send them checks. A company, in short, is a check-receiving work group. If the work group does good work, the other people (the customers) will send them lots of checks, and then the stock (which is a piece of the company you can buy) will rise. If the work group does bad work (or work that is not as good or as cheap as that done by other work groups), the customers will send fewer checks, and the stock will fall. (pp. 9–10)

This essentialized view of a company sets the stage for one of the most unique books on investing ever written. Mandelman emphasizes the importance to investors of having first-hand, exclusive information about a company’s people, products, plant, and periphery. A precautionary reason to seek out such information is to avoid investment losses: “If you invest in a company without knowing anything about its own specific drama, or characters, you’ll likely end up losing money” (p. 29). A proactive reason is to invest profitably—as Mandelman has done for decades at Giraffe Capital.

Mandelman first shows how to uncover exclusive data from those involved in a given company. He recommends establishing contact with the company’s cash makers—the people who “do the work for which customers send checks”—“chat with them often,” and visit the company (pp. 15, 19). Mandelman provides plenty of advice for beginning sleuths, including specific questions to ask management or oneself. When visiting the company, for example, he suggests asking of oneself questions such as:

Is the reception area decorated with samples of the company’s award-winning widgets and the CEO’s patent certificates, or with pictures of the CEO meeting movie stars and foreign leaders? In the first case, he serves the company; in the second, the company serves him. (p. 24)

That seemingly small detail is not available in press releases or annual reports. Yet Mandelman points out that such details can serve as crucial information when deciding whether you should invest in a company—just like an odd twist of the mouth or a single raised eyebrow from a nearby employee when management says they think the coming year’s sales will be good (p. 39).

According to Mandelman, a sleuth’s focus on people should not be limited to a company’s top employees. “In my experience,” he says, “low- and midlevel workers often know much more about their company than their bosses, yet many bosses rarely talk to the worker-bees, and even more rarely do they listen to them.” Because everyone likes to be listened to, however, Mandelman says that “if you just ask the workers questions with genuine interest, it’s likely that they’ll tell you whatever you want to know” (p. 139).

Mandelman also advises against confining oneself to researching the company’s own people. He recommends investigating a company’s customers—as well as its suppliers—figuring out “who pays whom, for what, how, and when.” Doing this, he says, provides you with information regarding the routine business of the company on a concrete, physical level. More importantly, it may enable you to spot significant changes before anyone else in the market. And this information, Mandelman points out repeatedly, can lead to huge profits.

Take, for example, the discovery by Mandelman’s friend George that a tech company celebrated extraordinarily profitable quarters by buying the staff kegs filled with champagne for a party on the day the earnings were released.

For an ordinary investor, this tidbit would have been a good anecdote to either rue Silicon Valley’s excess, or to highlight motivational management practices. But for a money sleuth like George, this was pure gold, and so the first thing that crossed his mind was, “I must find that liquor store!” (p. 128)

Mandelman goes on to explain how George found the store, told the clerks he heard they sometimes filled beer kegs with champagne, and explained that—as a collector—he would buy all of those bottles at one hundred dollars each, provided that he was called right away. Nothing happened at first, but nine months later George got a call from the liquor store that they had just put thirty bottles of champagne into a keg and that he could pick them up for $3,000. As Mandelman explains, George was more than happy to do so, for he now had exclusive information that the small tech company would report “blowout numbers” the next day and he could make a big investment on that basis. He did—with excellent results (p. 129).

Following a detailed look at a company’s employees, customers, and suppliers, Mandelman turns his focus fully to the company’s main product, its plant, and its periphery, showing how to evaluate the product and how to use what you learn about the route it takes from raw material to the customer:

What if the warehouse overflows, you ask? Oh, says the IR [Investor Relations] rep, then we bring a mobile trailer to serve as a temporary warehouse and park it behind the gym over there. That gym, you see when you leave, is visible from the hill behind the elementary school that you passed on your way. So now anytime you see a mobile trailer in XYZ’s yard, you know production has most likely been ramped up. You only have to go through that schoolyard and watch—or have someone local do it for you periodically. And, you ask, what if volume really breaks all records? Why, says the IR person, we would then work three shifts and have temporary employees park their cars in that one-way street in back, whose residents already agreed to it. (pp. 122–23)

To Mandelman, the goal of investigating both the product and the process it takes to reach a customer is the same as talking to everyone associated with the company: to learn of large changes in production and profits before the market does. Again, Mandelman highlights the value of such knowledge via memorable stories, then shows how to pull everything together via a “star map”—a comprehensive display of all the information one has gathered, similar to what you might see detectives use on television when investigating a criminal case.

Mandelman’s approach has some negatives, but he acknowledges and addresses them. He concedes, for instance, that the process can be lengthy and time-consuming, but he also makes the process less so by advocating a concentrated portfolio and showing how to discriminate companies worthy of investigation from those that are unworthy. He also warns that the SEC may charge you with insider trading if you cannot show how you learned something that they might assume you discovered illegally. For example, if you are investigating a small company that you think has a reasonable chance of being bought, then see the CEO having dinner with his counterpart at a much larger company in the same field, along with the top mergers and acquisitions guy from Morgan Stanley, Mandelman advises you to take a picture and date it before rushing to buy shares. Not doing so, he warns, will leave you at a loss to explain why you became so bullish right before the merger.

Unfortunately, insider-trading laws are nonobjective and written so vaguely that any investor who uses nonpublic information must fear prosecution by the SEC, even though he has done nothing morally wrong and regardless of the precautions he has taken. This is especially true now that the SEC is attempting to prove itself “tough” following a series of high-profile failures to prosecute the actual fraud that investors such as David Einhorn repeatedly pointed out to them. (See my review of Fooling Some of the People All of the Time, TOS, Summer 2009.)

In discouraging the search for and use of nonpublic information, the SEC’s actions have undoubtedly decreased the value of Mandelman’s book, at least for those investing within the SEC’s reach. Nonetheless, to the extent that the SEC has not outlawed due diligence, and for those investing outside its reach, The Sleuth Investor offers much value and may prove extremely profitable.