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Posted 10/24/2002

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The Speculator

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The Speculator
5 genuine buys on a Street of impostors
These days, a lot of bad stocks fool investors by sending just the right signals. We found five S&P 500 names whose stories hold up. Plus, four ways to spot a scumbag.
By Victor Niederhoffer and Laurel Kenner

Rewards have never been greater for those able to discern truly superior investment opportunities. Yet favorite buy signals such as buybacks and insider buying too often turn out to be misleading in individual cases. In the words of our favorite science fiction novel, "Invasion of the Body Snatchers," more than one company that seemed to fit our criteria "only looked, talked and acted" like one that really thought its stock was a good value.

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We have designed a new system to weed out impostors and used it to pick five stocks from the S&P 500 ($INX) that we think are genuine buys: Albertson's (ABS, news, msgs), Analog Devices (ADI, news, msgs), Dell Computer (DELL, news, msgs), Paccar (PCAR, news, msgs) and Xerox (XRX, news, msgs). Here's how we arrived at those choices.

We started by considering impostors in life and nature. The story of 1890s adventurer Louis de Rougement proved particularly inspiring. As told by Sarah Burton in her entertaining book, "Impostors: Six Kinds of Liar -- True Tales of Deception," de Rougement claimed to have survived 30 years in the vast Australian outback by convincing the cannibals that he possessed supernatural powers. Eventually, he found his way back to London and sold his tale to Wide World magazine.

The first installment of the story created a furor. De Rougement's account of riding sea turtles was widely ridiculed. "I have caught and handled some thousands of turtles," wrote an Australian, "and I never yet saw one which when afloat and when touched anywhere on its body did not sink almost vertically." An admiral weighed in on de Rougement's side: "I have considerable experience of turtle-catching, and know of a midshipman who got on a turtle and enjoyed a 10 minutes' ride before he brought the animal to a standstill." In 1906, the self-proclaimed cannibal chief rode a sea turtle at the London Hippodrome, disproving the naysayers. By then, however, investigative reporters had unmasked de Rougement as an imaginative former valet named Louis Grin.

They get what they want
On reading de Rougement's story, we realized we needed more than a mere sea-turtle test to avoid being fooled. This point was driven home when we read about the outrageous high-stakes frauds perpetrated by seemingly innocent plants.

European orchids not only look like bees, they smell like sexually receptive female bees -- all to seduce male bees into carrying pollen. A bee, after excitedly crawling all over an alluring flower and attempting union, quickly learns to distrust the fraudulent scent -- but 100 other types of orchids practice similar shams.

"After visiting four or five different plants, he has learned his lesson -- the whole lot that smell in this general way are useless and he visits them no more," writes David Attenborough in "The Private Life of Plants." "But by that time, he is likely to have done what the orchids required of him."

So it goes with investors. They are attracted by companies that buy back their stock, or have insider buying, only to be surprised, as in the case of WorldCom (WCOEQ, news, msgs) by disclosures of secret debts, vaporous earnings or magic-trick accounting for acquisitions. After a few encounters with such impostors, investors may be ready to give up on stocks entirely. But by then, they'll have made their contributions to the market.

Some plants practice deadlier deceptions, pretending to be food for a predator and then making the predator their prey. The pitcher plants of Southeast Asia are shaped like beakers, flagons, decanters and champagne flutes. Using copious amounts of nectar, they lure insects inside -- and then dissolve their trapped victims in digestive acid.

To avoid being fooled, seduced or eaten alive by our stock selections, we decided to require multiple signals before buying. Our evolutionary grounds for doing so are that no life form (and hopefully, no company) would expend the energy necessary to give off multiple false signals.

Three-signal monte
For most of this year, we have been writing about various signals emitted by companies. We've looked at buyback announcements, changes in inventory and accounts receivable, and changes in dividend yields, among other things. Now it's time to start putting some of these signals together.

We settled on three signals that we feel have been particularly efficacious:
  1. Buyback announcement
  2. Big decrease in inventory
  3. Big decrease in accounts receivable
As we reported in our column of April 18, companies that announced buybacks from year-end 1999 through March 2001 outperformed the S&P 500 by some 30 percentage points in the year after the announcement. We updated the study on Oct. 3 and found that the difference had diminished to a still-significant 6 percentage points.

Our Sept. 19 column reported on a 1970-1997 study by Jake Thomas and Huai Zhang showing that companies that report big decreases in inventory outperform those that report big increases by some 10 percentage points in the next year. For accounts receivable, the difference was 5 percentage points. We updated the Thomas-Zhang study and reported Sept. 26 that the five Dow Jones Industrial Average companies in 1998 and 1999 with the greatest inventory decreases outperformed those with the greatest increases, with the difference averaging out to some 10 percentage points.

To choose these signals, we conducted many tests that could be classified as negative studies. The buyback companies perform so well that additional criteria are not overly helpful. For example, we found that the percentage of shares bought back as well as insider buying within this group does not add significantly to the returns during 2002.

Our exploratory work shows a slight edge for the 93 companies that announced buybacks so far in 2002 and also reported the greatest decreases in inventory and accounts receivable. Buyback companies with the 10 largest decreases in inventory have beaten the S&P 500 by three percentage points year to date; those with the 10 largest increases in accounts receivable by one percentage point.

Only three companies displayed all three signals (a buyback announcement and membership on the top 10 lists for largest decreases in inventory and accounts receivable). Those three companies were Analog Devices, Paccar and Albertson's. Xerox and Dell were among the 10 companies with the largest drops in inventory and also had substantial decreases in accounts receivable, so we added them to the list.

Altogether, five companies met three tests indicating that they are not impostors. We will be buying them after the first substantial drop in the market that occurs after our column is published, as we are writing at an S&P 500 level of 900 and are waiting for a decline.

Final note
David Rosen, a very smart Chicago trader, spent many hours developing a profile of "the scumbag/user type" of impostor. Whenever he observes the following traits in someone, he says, "I know to run the other way." It seems to us that these characteristics could easily be applied to corporations, so we reprint them in full.
  • He is very fashionable/trendy. This includes everything he owns: Car, clothing, even his address has to be in the trendy part of town. This also includes where he likes to spend his time. He can't just hang out at "Bob's Bar," he has to be seen at the most fashionable spots in the city. He'll usually live above his means. He takes great effort to maintain his image, because image is all he has.
  • He is always looking for conquests. If he's married or has a girlfriend, he's cheating on her left and right. Whenever any attractive female passes by him, he is compelled to comment on her beauty to any men he happens to be with. This is often accompanied by a graphic description of what he'd like to do to her.
  • He refuses to admit possibility of failure. When making his investment/business pitch, he enthusiastically gushes on about how it can't possibly fail. The worst that can possibly happen is that you'll only make a little money on the deal.
  • He's your best friend right away. You've just met the guy, and he seems so happy to be around you and listens intently to everything you have to say. He acts like he's your new best buddy; in fact, he'll even literally call you "buddy" a lot to drive the point home.
"Beware of these four traits in anybody you're considering doing business with!" Rosen wrote. "Just one of these traits is enough to repulse me, but you'll often see the con man display three or even all four of these 'red flag' traits at once. Knowing how to accurately profile people is a skill worth fortunes."

Kindly send your thoughts about impostors and our column to us at, and we will send you the complete list of buybacks classified by changes in inventory and accounts receivable.

At the time of publication, neither Victor Niederhoffer nor Laurel Kenner owned or controlled any of the securities mentioned in this article.

MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.