FINANCIAL FRAUDS & MANIAS | James Chanos with Jim O’Shaughnessy on Infinite Loops

Key Takeaways

  • The fraud cycle follows the business cycle: The longer a bull market lasts, the more likely people will believe things that are too good to be true
    • Real frauds are revealed when the market goes down and people demand their money back
  • The fraud triangle (traits that increase the chances of fraud):
    • Is there pressure?
    • Is there opportunity?
    • Is there rationalization for wrong-doing? 
  • “We’re often swayed by people and not facts” James Chanos
    • “Smart guy syndrome:” When someone you consider smart makes a decision you don’t agree with, you follow the smart guy’s lead anyway because you think you may be missing something
  • James believes Tesla is a car company, not a tech company
    • “It is shocking how much of a car company it looks like…it’s a car company, it’s not a software company, it does not have 40-80% incremental margins, it has 15% margins”
  • James says Tesla is an excellent example of how a narrative of a company can divorce itself from its financial standing
    • “The narrative is propelling the stock, not the reality of the financials“ – James Chanos
    • EVs are the slowest adopted disruptive technology.
      • They’ve been around for 10 years &have less than 2% market share and declined last year

Intro  

  • James Chanos is an American investment manager. He is president and founder of Kynikos Associates, a New York City registered investment advisor focused on short selling
  • Hosts: Jim O’Shaughnessy (@jposhaughnessy) and Jamie Catherwood (@jfc_3_)

Books Mentioned

Being A Short-Seller

  • “Popularity has a price, even in the financial markets” – James Chanos
  • James has been running his own fund for 35 years
    • “Your shorts finance your longs” 
    • With short selling it’s your liabilities that move up and down. With longs, it’s your assets that move up and down
  • “If you want to think about the biggest short-selling scheme of all…it’s the insurance industry” James Chanos
    • People pay premiums upfront, the insurance companies invest & hope to earn a return, and hope to underwrite at little to no cost
  • James has one global and one domestic pool of shorts
  • Even if you’re right about a short position, the narrative behind a company can be so strong that the stock price can keep going up
    • James was right about AOL not being worth anything, but the stock went from $10 to $80 so he had to exit his position
    • AOL was later bought by Verizon and they wrote off the whole company
  • Short-sellers are lifelong pessimists, they’re financial detectives 

Financial Fraud

  • James teaches a course about the history of financial fraud at Yale and the University of Wisconsin
    • The course isn’t meant to convince students to become short sellers but rather to educate them that “fraud will touch their careers most likely at some point” – James Chanos
    • Students should know the dark side of business and be aware of the risks of financial fraud to keep their investment portfolio, career, and reputation safe
      • In his financial fraud course, James shares lessons the book, The Seven Signs of Ethical Collapse by Marianne Jennings 
        • A few signs to look out for:
          • Innovation like no other
          • Larger than life CEO
          • Very compliant hand-picked board
          • Charitable deeds to offset wrongdoings
  •  The fraud cycle follows the business cycle. The longer a bull market lasts, the more likely people will believe things that are too good to be true
    • The real frauds are revealed when the market goes down and people demand their money back
    • “Most frauds today tend to be either accounting and or ponzi-schemes” – James Chanos
  • The fraud triangle (traits that increase the chances of fraud):
    • Is there pressure?
    • Is there opportunity?
    • Is there rationalization for the wrong-doing? 

Financial Fraud Example: Theranos

  • The book, Bad Blood by John Carreyrou, tells the story of the rise and fall of Theranos
  • Warning signs:
    • Theranos had an older white-male board
    • There was a dread of missing out on a life-changing technology
    • The company’s founder was a woman. There was a trend to invest in companies with diverse leaders
      • “We’re often swayed by people and not facts” James Chanos
        • Walgreens hired an outside expert to look into Theranos but Theranos didn’t let the expert talk to their engineers or conduct a double-blind test
        • The expert told Walgreens not to do a deal with Theranos but they ignored his advice and did it anyway
        • Why? Walgreens was afraid CVS would do the deal with Theranos (FOMO)
  • Watch out for the “Smart guy syndrome”: When someone you consider smart makes a decision you don’t agree with, you follow the smart guy’s lead anyway because you think you may be missing something
  • The book, Talking to Strangers: What We Should Know about the People We Don’t Know by Malcolm Gladwell, talks about how people default to trusting people which allows bad apples to take advantage  
    • When picking what companies to short-sell, Jim WON’T talk to the companies’ management teams
    • If the company is committing fraud, they won’t admit it.
    • They will try to persuade Jim that everything is legitimate

Is Tesla A Fraud?

  • James believes Tesla is a car company, not a tech company
    • “It’s gross margins, X the tax credit sales, are 15-percent which is right in line with the industry” – James Chanos
      • “It is shocking how much of a car company it looks like…it’s a car company. It’s not a software company. It does not have 40-80% incremental margins, it has 15% margins”
  • James says Tesla is an excellent example of how a narrative of a company can divorce itself from its financial standing
    • “The narrative is propelling the stock, not the reality of the financials“ – James Chanos
    • “EVs are the slowest adopted disruptive . . .technology in recent memory…EVs have been around for 10 years. They have less than 2% of the market sales and declined last year”
      • “This is about Tesla the brand, it’s not even about EVs I think”
      • “This is a company that’s been around for 16 years and never made any money, it’s not a startup”
  • James does give Tesla and Elon Musk credit for making electric vehicles sexy

Infinite Loops : , , ,
Notes By Alex Wiec

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