Earnings Call Forensics and the Red Wheelbarrow

You wouldn't lend a good friend $100,000, no questions asked...

Yet every day, people invest hundreds of thousands – if not millions – of dollars buying stocks based on Google Finance charts... stories in online magazines... or reports cranked out by some Wall Street "expert" trying to sell you shares.

Think about it. If your buddy asks you for a hefty loan, would you give him a form to fill out and e-mail back to you? Would you make your decision based on a PDF of his business plan?

Or would you meet with him, look him in the eye, and ask him as politely as possible... "So, how exactly are you going to spend the $100K I'm going to give you?"

I hope you'd choose the latter.

Of course, a business plan and financial metrics are still important. But by talking to your friend face-to-face, you'll be able to hear his tone and emotions – and watch for any physical or verbal tells. No matter what you do, you shouldn't just send him an e-mail.

Even if you go so far as to grab the financial statements and plug some numbers into a spreadsheet, that's still novice research. J.P. Morgan – the man, not the bank – would never have approved of such shoddy credit analysis.

If you wouldn't invest in a good friend without face-to-face due diligence, how on Earth can you buy stock in some company... trusting a total stranger with your hard-earned dollars?

The most successful investors know that doing your due diligence means getting your head out of the spreadsheets and earnings reports. You've got to take real measure of the people who run the companies where you place your money.

Our "Do Not Buy" list, which we publish every quarter for Microcap Confidential subscribers, proves that fraudulent management teams often go unstopped for years – even after we've caught them. Folks are so busy looking at easily manipulated numbers that they miss the real story.

And Wall Street often misses the mark on good companies, too... keeping them "blacklisted" based on short-lived mistakes. (If you want to learn more about Wall Street's Blacklist – and claim our latest Do Not Buy report – click here to get started.)

While you may never get invited for drinks by the pool with Jamie Dimon or Elon Musk... you do have the opportunity to hear what the top brass thinks. As I'll explain today, it's a critical tool for making judgements about your investment targets. You just need to put in the work to take advantage.

'It is not what you say that matters'...

This saying comes from American poet William Carlos Williams, a contemporary of Robert Frost. The full quote is this: "It is not what you say that matters, but the manner in which you say it. There lies the secret of the ages."

It's no surprise that Williams understood the importance of reading between the lines. One of his most famous poems, XXII, has been a source of debate for the past century...

So much depends
upon

a red wheel
barrow

glazed with rain
water

beside the white
chickens.

Williams penned this poem, known more commonly as "The Red Wheelbarrow," in 1923. Even though it's incredibly short, high school and college English classes still dwell upon and debate its meaning to this day.

Many people interpret it differently when they read it versus when they speak it aloud.

Similarly, when you invest in a business, it shouldn't just be because of the numbers, strategy, or plan. Much of your decision should be based on how company executives respond to questions and convey information – on the confidence in their voices and the strength of their conviction.

Anyone can type up words into a document. But listening to how they discuss the business gives you a totally different level of insight than just reading that data on a page.

In short, Williams was right...

What management says is nowhere near as valuable as how they say it.

Longtime readers know that I often teach masters-level finance classes at Hult International Business School. I try to make my stock-valuation courses as real as it gets.

Before students pitch an idea, I ask them to listen to the past several quarterly earnings calls. They end up with a markedly higher level of understanding about the state of the company and its major initiatives.

The fact is, most of us are naturally good lie detectors. We have built-in senses for reading people... picking up on vocal inflection and understanding the emotions behind the words.

Of course, not everyone has time to tune into each earnings call. So investors often resort to skimming the transcripts – or relying on other people to do it for them. It's inadequate research.

That's why at Altimetry, we have something called the Earnings Call Forensics ('ECF') analysis...

Aided by advanced audio technology, we listen to management's earnings calls in a systematic and incredibly sophisticated way. We measure inflections in their speed of speech, tone, hesitation levels, and even changes in "breathiness." Then we compare that against their spoken words and the numbers.

No one on Wall Street has anything that comes close to this level of research power.

This proprietary research contributes to our fundamental analysis. Sometimes, inflections in company leadership's tone or vocal inflections will factor into the timing of our recommendations.

For instance, the ECF analysis gave us confidence in Facebook – now called Meta Platforms (META) – long before it became the social media behemoth and Wall Street darling it is today.

Back in 2013, when the stock was trading for around $25 per share, we were intrigued by the potential of its market platform for ad servicing. Our ECF analysis confirmed that management enthusiasm for this part of the business was genuine... and we directed our clients to invest in the company.

Through 2014 and beyond, escalating ad revenue started to show up in Facebook's financial statements. Wall Street picked up on the story. In total, we generated a return of more than 1,300% for our institutional investors between May 2013 and October 2021.

We've run more than 40,000 management calls through our ECF system. In aggregate, we capture and create a "Management Sentiment" index, which we use every month in Altimetry Daily Authority as part of our Monday market analysis.

You probably put this practice into your personal life already...

When my teenager asks me to stay over at a friend's house, I don't text back asking what they'll be doing. Instead, I say, "Great. Let's discuss it." (And I often add a smiley face emoji.)

It's not what he says that tells me what's really happening on Saturday night. It's how he sounds when he says it.

You can't perceive emotional context through the written word – not with kids, not with romantic relationships... and certainly not with management teams.

Wishing you love, joy, and peace,

Joel
August 26, 2022