Fuzzy Logic, or: Those Who Fail to Learn From History

I firmly believe the influx of people (many “quants” but others as well) in Finance over the past decade who posess little-to-no knowledge of Financial history contributed to the bubble and the resulting collapse.

Unfortunately, many of these people who know not the many, many lessons of financial history are lured into finance by the promise of money and all that comes with it.  More unfortunately, despite the many and various lessons of which we’ve been recently reminded during/after this most recent crash, many of these people are still among us.

Today, I read an article about China Media Express Holdings, and how its going to be the biggest short squeeze the author has ever seen/of 2011.  My 1st reaction was that whoever this author was (I’d never heard of him), he must not have been around for very long.  Remember Volkswagen (to use but one recent example)?

Apparently the short thesis is that the company is a fraud.  I do not know this company well, so I can’t speak to that point, however, I CAN and will now, for your viewing pleasure, proceed to destroy the author’s rationale for why the firm ISN’T a fraud.  He says:

1. CCME has been fully vetted by Starr International — headed by Hank Greenberg –4 months. Also on the board of directors and checks monthly numbers.

Big deal.  Remember AIG Financial Products?  Bang-up job they did!  Surely all the problems started after Greenberg left (debatable).  Regardless, numbers can be fudged, easily.  More on this later.  Additionally, 4 months is not a sufficiently-long track record for this point to be used to support a long thesis in my opinion.

2. CCME has been independently vetted by Global Hunter — 3 months.

What the hell is a Global Hunter?  Is that a video game?  Again, 3 months is not a very long time at all…

3. CCME has a top four auditor, Deloitte.

Deloitte was also Bear Stearns’ auditor…

4. It is #1 on the Forbes China List of Small-to-Medium Sized Companies with the Greatest Potential.

If you get your investment advice from Forbes you should just give me all your money now and save yourself the trouble.

5. Its Zack’s Rank is #1.

Its not even on the top 10. What the hell is this guy talking about?  It wasn’t on the top 10 last year, either!  Is there another Zack’s I don’t know about?

6. Investors Business Daily gives CCME top marks, best marks out there actually.

Yea, “top marks” for EPS growth, but IBD doesn’t even rate CCME as the top stock in its group! High EPS growth alone does not a solid long-thesis make.

7. Its CFO is a former auditor of Price Waterhouse Coopers, who just bought $1.5 million of stock.

I’m more inclined to consider this an orange (if not red) flag, rather than a green one.  Sure, it’s good for a CFO to have a solid grasp of accounting, but posession of such knowledge can be used for trickery, as well.  Again, more on this later

8. Dividend policy starting in the next 90 days.

And the point is what, exactly?  No firm that was eventually proven a fraud paid a dividend?  Challenge.

9. Signed contracts with Apple(AAPL_), Nike(NKE_), Sony(SNE_), Adidas, Toshiba, etc.

Have all of these companies confirmed these contracts not only exist, but exist as CCME has represented?

10. Independent investors have visited the company and not found indication of fraud.

Ask Sam Antar, co-mastermind behind the Crazy Eddie fraud(s).   Just because you can’t see fraud doesn’t mean it isn’t there.

11. Mike Koza, who has averaged 33% a year for almost 10 years, owns CCME.

What % of his portfolio does his CCME holdings represent?  How long has he held it for?  What’s his investment thesis?  Is it a momentum play or a fundamental one?  In order for this last point to hold any credibility as a reason to be long the stock, each of these questions needs to be addressed.

Oh, and one last thing: The firm that last year called Rino International a fraud has just initiated coverage on CCME, referring to this firm as a fraud, as well.

Their rationale seems to be a bit stronger than Bradford’s:

Muddy Waters LLC has initiated coverage on China MediaExpress Holdings, Inc. (CCME) with a Strong Sell rating and an estimated value of $5.28.

• Muddy Waters, LLC believes that CCME is engaging in a massive “pump and dump” scheme whereby it significantly inflates revenue and profits in order to enrich management through earn-outs and stock sales.
• We estimate that CCME’s actual 2009 revenue was no more than $17 million (versus $95.9 million it reported).
• The data CCME provides to advertisers shows that it has fewer than half of the 27,200 buses it claims to have.
• The CTR reports that the Company uses to support its claims contain gross errors that we conclude are due to manipulation by the management.
• We estimate that over half of CCME’s network buses do not actually play CCME content. Rather, drivers play DVD movies that are often provided by passengers.
• We caught CCME’s management telling a particularly egregious lie – that its new website (www.switow.com) has entered into an agreement with Apple (or one of Apple’s) distributors. Neither is true.
• Similar to RINO, CCME is an obscure company in its industry. Media buyers who would have to know it if CCME were to be believed have never even heard the Company’s name before.
• CCME’s core audience is sub-Greyhound Bus demographic.

Only time will tell how this shakes-out but today, it looks like that call for a massive short-squeeze was not only premature, but extremely naive.  CCME is already down 33% today on this news.

I don’t like engaging in ad-hominem attacks but the author, Glen Bradford’s investing experience/background (provided in his bio), in consists of a bachelors in engineering combined with an MBA (one of those 3+2 programs), which he completed less than a year ago.  It also looks like he’s been trading his own account for 2 or 3 years (maybe more?) quite successfully.

I don’t know Glen, but from reading this article and a few of his others, he strikes me as one of the people I mentioned earlier.  A guy with brains and drive who thinks he can “make it” in Finance, yet possesses little-to-no knowledge of the many lessons learned by investors past.

If you don’t know the stories of LTCM,  Enron, Tyco, Worldcom, Adelphia, Global Crossing, the S&L Crisis, how portfolio insurance contributed to the 1987 crash, or countless other lessons going back centuries, then you have no business investing your or anyone else’s money.

Actually, wait.  Go ahead and try to be an investor, just don’t be surprised when your ignorance comes around to bite you in the ass.

UPDATE: I’m reminded the Zack’s that the author was referring to may be http://www.zackspro.com/zind_zrank.asp I do subscribe so I can’t speak to whether his claim is accurate or not. h/t BHA