As seen in the Globe & Mail on September 20, 2023 (for subscribers only)
What is ‘scuttlebutt’? And, how can using scuttlebutt generate alpha—that coveted, yet often illusive investment metric that measures excess return relative to a benchmark index? The etymology of the term comes from seafarers early in the 20th century. The ‘scuttle-butt’ was the cask of potable water on the ship’s deck where sailors congregated and gossiped while at sea. Think of it as the nautical version of the caffé klatch or office water cooler chit chat.
Contrary to popular belief, successful investing over the long term is not only about parsing data; today, any beefy computer can do that. Consistently generating alpha, will generally mean diverging from the consensus view. This requires other skills, and some of these, like mastering the art of scuttlebutt, are not taught in business schools but are learned on the job.
Why scuttlebutt matters
To be clear, scuttlebutt does not mean trading on insider information. Instead, it involves being a dogged investigator, much like an ace reporter or forensic expert, to gain a deeper understanding of a company’s business from multiple viewpoints. Scuttlebutt complements financial analysis by adding a qualitative component to the quantitative data that builds a mosaic from non-material and non-public information. An example would be meeting with restaurant franchisees about customer traffic, customer menu preferences or average ticket size to understand the payback of a location, or meeting with a farmer about what is most important for them to better understand issues relating to AgTech companies. The goal is to bring the company’s numbers to life and assist in determining if it is likely to be a good investment.
How to use scuttlebutt to gain differential insights
Once there’s a deep understanding of the company’s financials, it’s time to get to work. This means reaching out to both internal and external stakeholders. Internal stakeholders can include management, employees, owners, and even former employees. External stakeholders may include suppliers, customers, creditors, shareholders, government agencies, as well as competitors and industry experts.
In our highly digital age, it is amazing how much valuable information can be collected by simply making a phone or Zoom call or meeting someone for a coffee. Beyond annual reports and shareholder meetings, this is how to gain a deeper understanding on such factors as: How the company makes money and how much is recurring revenue; how could a competitor hurt the business, and what keeps the owners/managers up at night? And, perhaps most importantly, what is the quality of the management team?
Other sources of quality information include accessing interviews with industry experts and reading meeting transcripts from services such as AlphaSense and Tegus, surfacing insights about the company culture and personnel changes and job postings through LinkedIn and Glassdoor, as well as from blogs, message boards, forums, and review sites. Google Trends, Google Adwords, and ChatGPT can provide further insights on the popularity of firm’s products or services.
Fundamental, bottom-up investors have an affinity for scuttlebutt because they search for something “awesome around the edges” that others may overlook. It will come as no surprise that Warren Buffett is a proponent of scuttlebutt. One famous example is The Great Oil Scandal of 1963. American Express had extended a large loan to Allied Crude Vegetable Oil, a salad oil company. The loan was based on collateral of $150 million of oil. It turned out that the company faked its inventory by filling its tanks with seawater and only a small amount of oil which floated on top and was undetected by inspectors. This created substantial loan losses for American Express and its stock rapidly dropped 50%; consensus was the company could go bankrupt. Buffett tested this consensus view by visiting local restaurants. What he saw was that customers were still happily paying for their meals with AmEx credit cards. He concluded the customer franchise remained solid and he took a 5% position in the company. The subsequent recovery in AmEx shares generated tremendous profits for Buffett well in excess of the returns of S&P 500 during 1964-1967.
With the growing abundance of public company information and data, the notion of adding a scuttlebutt or “boots-on-ground” component may be seen to be antiquated and superfluous. Nothing could be further from the truth. If everyone else is consuming the same information and coming to the same or similar conclusions, having an investing edge is essential to assist in generating alpha. Just ask Buffett.