Lessons from a 19th century "Rattlesnake King": How can you apply these to your investments?

Wednesday: The Independent Investor FROM THE DESK OF MILES EVERSON: Hello, everyone! We’re thrilled to talk about our topic for today’s “The Independent Investor.” Every Wednesday, we publish articles about basic investing tips. Our goal is to help you strategically think about your financial choices through the coaching comments and insights that we write about. In this article, we’ll focus on what you should look out for when researching companies you’re planning to invest in. Keep reading to know how you can protect yourself from corporate “red flags.” CEO, MBO Partners Chairman of the Advisory Board, The I Institute

Lessons from a 19th century "Rattlesnake King": How can you apply these to your investments? Clark Stanley, a.k.a. the “Rattlesnake King,” always knew how to put on a good show. Picture this: During the Wild West in 1893, there was no Netflix yet. So, to pass the time, people would go to the town square to watch different live shows, and one of those was the medicine show by the man who called himself “Rattlesnake King.” There, he boiled a rattlesnake in front of his audience and then sold his patented snake oil. His claim? His product could heal various maladies—from rheumatism and pains to sprains and burns! Originally, the idea of the medicine came from China. When Chinese immigrants came to the U.S. in the 19th century to work on the transcontinental road, they brought their traditional medicine practices with them, including the snake oil liniment. According to Chinese beliefs, the high concentration of Omega-3 fatty acid in Chinese water snakes made them a therapeutic method for treating the pains workers experienced from their back-breaking labor. So, it’s true. Snake oil actually helped with curing aches, pains, arthritis, bursitis, and the likes. No wonder Stanley thought about making a business out of it. The problem? Stanley’s snake oil was NOT the real thing! Stanley’s rattlesnake ≠ the Chinese water snake… and while it’s true that rattlesnakes also contain Omega-3 fatty acid, it’s not as high as that of Chinese water snakes, so the therapeutic effects are somehow diluted. Oh, and another thing: Stanley’s product didn’t even contain snake oil. When authorities tested his concoction almost 25 years later, they found out it was simply a mixture of mineral oil, red pepper, turpentine, and cow fat. What a scam! Unfortunately, by the time authorities found this out, Stanley had already been selling the product for 24 years and victimizing consumers—intelligent and gullible alike. Stanley’s trial for misbranding his product and “falsely and fraudulently representing it was a remedy for all pain” was a turn-of-the-century media circus, but in the end, he was only charged USD 20 (equivalent to around USD 465 in today’s currency) for all the damage he had done. Wait… what about all those who had fallen victim to Stanley’s fake product? How were they compensated? To answer that question, they weren’t… and that’s the sad reality. A Lot More Fraud is Out There The victims of Stanley’s fake snake oil liniment in the 19th century couldn’t rely on the regulators to protect them over such a fraud. Sadly, not much has changed today, especially in the world of investing. So, investors, remember this: In investing in small companies, don’t expect that the government will always be there to look out for you. In some cases, these businesses could do a HUGE damage to your portfolio if you don’t know what to look out for. In fact, a recent study in the “Review of Accounting Studies” journal shows around 10% of large public companies commit securities fraud in any given year. What’s more? Fraud destroys an estimated 1.6% of total equity value annually. The thing is, defining fraud can be tricky in the world of investing. It’s not simply talking about legal fraud or alleging crimes. Instead, it’s when a company misrepresents any figures to the public, and this includes misstatements and restated financials. That’s why as an investor, you need to be alert AND aware. How can you protect yourself from corporate “red flags?” Do your own research. The oversight boards that keep public companies in line usually focus on the big fish. This means if you want to invest in small companies, you have to research carefully and thoroughly. Pay attention to the key players involved in a company. Look at the quality of the auditor, whether or not executives have a history of trouble with regulators, and questionable headquarter locations. These “red flags” are dead giveaways that the company you’re looking at is at higher risk of fraud. At the very least, the management team probably isn’t acting in the interest of shareholders. Look for delinquent filings. High management turnover and constant promotions can signal that a company engages in misleading practices. Also, check if a firm has been delinquent with its U.S. Securities and Exchange Commission (SEC) filings. This implies the business has bad actors in its management team, among other issues. In short, when researching a company, it’s important to do your homework. This is especially true for smaller companies because they’re less regulated. However, companies of all sizes are susceptible to such issues too. So, before making an investment, make sure you know that particular company’s key players as these are the folks steering the ship. Ensure they’re taking the company in the right direction. Besides, the only person who will care for your money is YOU! Don’t blindly trust that the management team or the government will look out for your interests as an investor. Make sure you’re confident in a company before putting your money to work.     Hope you’ve found this week’s insights interesting and helpful. Stay tuned for next Wednesday’s The Independent Investor! Are you familiar with the term, “black swan?” Learn more about the 6 “snow leopards” to watch out for in 2023 in next week’s article!