Let’s do the scuttlebutt
Matthew Vincent says that some of the world’s greatest investors rely more on gossip and observation than on studying balance sheets Why do City types routinely don garish golfing apparel? Why do financial journalists habitually hang around in bars? At first glance, these tendencies may strike you as more inevitable than imponderable. But there is another explanation. They may be hoping to do the ‘scuttlebutt’. This may sound like the sort of 1930s dance craze that you’d expect Psmith, P.G. Wodehouse’s City type and journalist, to indulge in, but it’s actually a more profitable practice, devised by a Wall Street investor of a similar vintage. Essentially, scuttlebutt is an investment strategy based on the business grapevine — what the modern-day Psmith (MBA) would doubtless term ‘networking’.
Of course, even back then, it wasn’t a new idea. ‘Scuttlebutt’ was a long-standing nautical term for gossip. It was derived from the combination of ‘scuttle’ (to let water in through a ship’s hull) and ‘butt’ (a cask to hold drinking water), because the ‘scuttlebutt’ was where the ship’s crew would congregate to gossip about the captain, the pirates, the weevils in the ship’s biscuits and other pressing issues of the day: think 18thcentury ‘water-cooler moment’. What was new, by the 20th century, though, was its application to company analysis. Substitute captain for management, pirates for competitors, and biscuits for supply chain — and you have an alternative approach for picking stocks. What’s even more remarkable is that the scuttlebutt approach has helped seal the reputation of Warren Buffett as the world’s most successful investor, and Fidelity as the world’s largest independent fund management company.
But it was from another, lesser known source that these Wall Street and City types first learned of scuttlebutt. Philip Fisher was an American who, in 1931, decided to set up his own investment advisory business. He would only buy stocks after talking to companies’ employees, competitors, suppliers and customers — although he favoured the factory floor or trade exhibition over the golf club. And sometimes, after gathering this evidence, he wouldn’t buy. In fact, at the busiest point in his career, he owned only 25 stocks, and reckoned he bought no more than 50 in 70 years. What he did buy, though, he held for years, so sure was he of his research. This led him to invest in Motorola in 1955 when it was just a radio manufacturer. It also inspired him to write a book, Common Stocks and Uncommon Profits, which was published in 1958. Over the following 21 years the value of his Motorola holding rose twentyfold. Over the same period his book became the first investment title to make the bestseller list — and it’s still in print today, published by John Wiley & Sons.
Reading it now, the most striking aspect of his description of scuttlebutt is its simplicity. He devotes just three pages to it. ‘The business “grapevine” is a remarkable thing,’ he writes. ‘It is equally astonishing how much can be learned from both vendors and customers.’ What’s even more astonishing is the success that others had in following him. Warren Buffett says, ‘A thorough understanding of the business, obtained by using Phil’s techniques, enables one to make intelligent investment commitments.’ Those techniques enabled Buffett become the second-richest man in the world.
Another who has concentrated on Fisher’s scuttlebutt ideas is fund manager Peter Lynch. In his book, Learn to Earn, Lynch brings scuttlebutt into the modern age. ‘Every time you shop in a store, eat a hamburger, or buy new sunglasses, you’re getting valuable input. By browsing around, you can see what’s selling and what isn’t. By watching your friends, you know which computers they’re buying, which brand of soda they’re drinking, whether Reeboks are in or out.’ These important clues led investors in his Fidelity Magellan fund to exactly the right stocks, year after year. Lynch managed the fund along these lines from 1977 to 1990 and produced a total return of 2,700 per cent.
So how, then, do you do the scuttlebutt as a private investor? Fisher suggested 15 investigations on which no investor should ever compromise. Some of these are easy to carry out in the bar or the clubhouse: ‘Does the company have products or services with the potential to make possible a sizable increase in sales? Others, however, would require sinking putts or pints with the company’s finance director. ‘How good are the company’s cost analysis and accounting controls?’ Nevertheless, there is still plenty of useful scuttlebutt that can be gathered from staff and customers.
Retailers are arguably the most obvious place to start. A couple of years ago you would only have had to talk to a customer or a shelf-stacker in Sainsbury’s to know that Tesco was the stock to buy. ‘Empty gaps on the shelves are a real giveaway,’ said Seymour Pierce analyst Rhys Williams at the time. ‘Every time I go shopping at Sainsbury’s there are basic items I can’t buy.’ Another giveaway is the over-generous unseasonal giveaway. Most memorably, in 2003 Marks & Spencer’s shares fell 12.5 per cent in seven weeks when investors spotted its 20-per-cent-off promotion on all knitwear, in the autumn.
Pubs, too, are not just a place for chatting to business contacts. If you’re the only people at the bar, it tells you a lot about the company. Ask a J.D. Wetherspoon customer what he thinks about the smoking ban and the lack of tellies showing World Cup football, and you’ll know why the shares are rated a ‘sell’.
Airlines can provide contrarian investment indicators, too. If you’ve ever flown on a low-cost operator, you’ll know the relief that comes from finding empty seats beside you rather than a family of flatulent Belgians. If you’re a shareholder, though, this should make you feel even more discomfited. That’s why easyJet’s shares fell 2 per cent on the release of its January traffic figures — its load factor had dropped from 76.4 per cent to 74.2 per cent. And talking to pilots can be even more revealing. Bill Mann of motleyfool.com bought into the near-bankrupt Delta Airlines, after a conversation with flight crew made him realise that they would accept a reduced pay deal to help the stock recover. It duly did, rising 127 per cent in the last quarter of 2004.
It’s not just in consumer-facing industries that you can gather scuttlebutt, either. Estate agents can provide information on housebuilders — Persimmon looks good value. Children can give insights into mobile-phone content — Stream is a buy.
But, before you head off to do the scuttlebutt, do remember: it’s not an investment strategy in itself. You can’t just buy what you know without also buying into the company’s cash flow and balance sheet. And, despite its etymology, it’s not about spurious rumour. As another Wodehouse character, Freddie Rooke, found to his cost, ‘A silly ass at the club named Jimmy Monroe told me to take a flutter in some rotten thing called Amalgamated Dyes. It’s not the money. It’s the principle of the thing. I hate looking a frightful chump.’