Business Analysis:The Scuttlebutt Approach

March 18, 2008

Scuttle butt approach in investment was popularized by Philip A. Fisher.In his book,’Common Stock,Uncommon profit’,Philip explained that an investor can get better view of a company by interviewing its competitors and vice versa. Information about a company should be obtained at from employees, customers and clients.One should not ask its management because the management will paint the outlook with beautiful colors since it involves conflict of interest. To perform scuttlebutt, one must have a good network with many people in various industry.By socialising with these contacts,one can get a better picture before putting his hard earned money into the business. Sources of information are competitors,vendors,customers,professors and employees. Reading news from research houses and newspaper is not adequate because these sources have filtering system. The research houses and media act like the advertisers of public listed companies rather than helping the investors to understand the business.They are paid to do so.Scuttlebutt approach helps investors to obtain confidential information and ‘insiders’ information’.Of course,the investors must be very good with his communication skills to indirectly dig more information from these sources.Remember,knowledge is power!What are the basic information which an investors should look for? I highlight the questions below.

1. Do these companies have products with market potential to increase sales for at least several years? Your target company may be harvesting profits currently, but it may lack long term potential. This question can help you discern the company’s prospects (and yours).

2. How effective is R&D in relation to its size in each company? Looking at the financial ratio between total R&D expenditure and total sales is a popular but crude way of thinking about R&D commitment. Such ratios can be misleading. When evaluating a company’s R&D efforts, it is just as valid to inquire about market research as technology research. So, find out how the company investigates (and develops) its market.

3. Can you describe the sales organizations of these companies? Information about the sales operation is seldom discussed in financial reports of public companies. Fortunately, this information is easily obtained using Scuttlebutt. Of all aspects of a company’s activity, the most well-known to sources outside the company will be the sales organization.

4. How would you compare these companies’ profit margins? Sales are of value only when they lead to profits. You want to find out what the target company is doing to maintain or improve profit margin. Scuttlebutt can give you a glimpse into a company’s profit future.

5. How would you describe the way these companies treat employees? Within an industry, it is generally known that there are “decent” companies. It is also generally known that there are companies that “burn up and discard” people. Senior management is often blind to its own reputation, but others will see it clearly.

6. How would you compare depth of management? A small company can do extremely well under an able autocrat. What would happen if that key person were no longer available?

7. How would you compare these companies’ cost analysis and accounting controls? It is not difficult to churn out reams of accounting information. The tough questions are, how valid and useful is this information, and how effectively does management act on it? The Scuttlebutt method is helpful here in revealing significant problems that won’t necessarily appear on the balance sheets.

8. How would you compare the integrity of management? Without breaking laws, there are ways in which senior managers can benefit themselves at the expense of customers, employees, and stockholders. Such managers are generally known within their professional communities. The only real protection against being abused by such managers is to avoid getting involved with them.

It can be very difficult to obtain the information you need about a privately-held company. Scuttlebutt gives you access to the professional assessments and opinions of people who know a company. It’s not perfect information. However, by cross-referencing the answers you get to the questions we have outlined, you can form a picture of your target company. Scuttlebutt helps you combine your judgment with that of industry insiders to draw reasonable conclusions.