Don't Let the 'Root of All Evil' Tank Your Portfolio

Editor's note: Greed can be your worst enemy as an investor. That's why Joel Litman – founder of our corporate affiliate Altimetry – says if you're seeing signs of this trait in a company, run for the hills. In this article, adapted from a May 2023 issue of the free Altimetry Daily Authority e-letter, Joel details how to avoid falling victim to corporate mismanagement... and help save your portfolio from huge losses.

David Duncan figured it was better to obstruct justice than let Enron's paperwork sit in his filing cabinet...

At auditing firm Arthur Andersen, Duncan was one of the lead auditors on the Enron account in the late 1990s. Enron had won a reputation as a fast-growing energy company, and everyone wanted in.

Auditing or consulting for Enron was prestigious... and massively profitable. The company reportedly paid Arthur Andersen $1 million per week just for audit fees.

Duncan and other auditors had known Enron was playing accounting games since at least 1999. Even so, they kept signing off on Enron's financial statements. Duncan even praised and defended some of the company's choices.

Eventually, that would come back to haunt him...

In 2001, Enron quickly transformed into a massive headache. The company was gearing up to announce a huge $618 million loss on its third-quarter financial statement.

Enron knew it couldn't keep propping up revenue with its games... And Duncan knew the end was near. So Duncan and his team shredded boxes full of Enron documents.

Duncan was later charged with obstruction of justice. One of the memos he sent in support of Enron's shell companies was used as evidence against him.

The case destroyed the public's trust in Arthur Andersen. To make matters worse, the authorities discovered it wasn't the firm's first time committing fraud. And by 2002, it was practically defunct.

We've seen this plenty of times in the financial world. Some of the worst examples of corporate fraud – and greed – have dealt serious blows to the economy.

It's not that wealth is inherently a problem. The real danger is when people become too attached to money... not the money itself. And as I'll explain today, that risk extends to your portfolio.

There's a famous saying that "money is the root of all evil"...

This well-intentioned reminder gets misquoted and misinterpreted all too often. The actual quote, which comes from the Bible, is as follows...

For the love of money is the root of all evil.

Money is no more than a tool. It can be used for good or for bad... like what happened with Arthur Andersen and Enron.

Greedy people become all too eager to get money at the expense of others. They accumulate a bigger piece of the pie while making the pie smaller. And the results are often devastating for everyone involved.

In contrast, the most successful entrepreneurs realize early on that the best path to wealth creation is by solving the needs of society.

Integrity is the most often cited trait that self-made millionaires claim is necessary to success. Greed is not.

Accumulating a large slice of pie while making the pie bigger... that's a great use of money. It's how we keep track of companies that are adding value (creating wealth for shareholders and growing) and those that aren't.

We'd all like to think that greedy, unscrupulous management teams are few and far between. Unfortunately, that just isn't the case.

Look no further than the land of microcap stocks. This space is full of opportunity – but it's still the Wild West of underpoliced public entities.

Companies with market caps of less than $1 billion don't get the same coverage as their bigger peers. Fewer Wall Street analysts and journalists pay attention to them... So they get less outside scrutiny.

Meanwhile, their shareholders aren't usually corporate pension funds or government-employee retirement funds. The U.S. Securities and Exchange Commission and attorneys general have far less reason to watch over microcaps. And that makes them a breeding ground for management teams looking to enrich themselves at the expense of others.

But that doesn't mean you have to fall victim to their cash grabs. A few telltale signs can help you avoid investing in greedy companies...

When I recommend microcaps in my newsletters, my team and I run companies through a rigorous checklist that we call "fundamental forensics."

It looks for red flags like a weak auditor... a management team of "bad actors" with prior fraud involvement... a disreputable or falsified headquarters location... and any "related-party transactions," meaning the company is using corporate funds to line management's pockets on the side.

Every quarter in our Microcap Confidential advisory, we publish a "Do Not Buy List" of companies that have failed this test. It's how we identified a company called NantKwest – now ImmunityBio (IBRX) – in July 2020...

When we ran NantKwest through our fundamental forensics analysis, it turned up a lot of negative signs. For instance, back in 2016, the company leased office space from a property owned by Chairman and then-CEO Patrick Soon-Shiong.

That means the company was paying the CEO rent, in addition to a salary... And in 2019, he raised rent almost fivefold.

That was just one of the red flags we saw. Since we warned subscribers to steer clear, ImmunityBio has repeatedly raised more capital from unsuspecting shareholders. Yet the stock is down almost 50% since we first flagged it.

Our Do Not Buy List currently includes 54 problem companies... that have the potential to turn into portfolio "torpedoes." On average, shares of these companies have fallen more than 50% within just nine months of our flagging them.

To be clear – I'm not saying you should avoid all microcaps. Just like how money isn't inherently bad, tiny companies aren't automatically dangerous or untrustworthy.

Each month in Microcap Confidential, my team and I identify a misunderstood opportunity that has the potential to soar in the coming months and years. Each recommendation has received a clean bill of health from our fundamental forensics test.

Checking the same key traits helps us find – and trust – companies like online real estate brokerage eXp World (EXPI)... which we also highlighted in July 2020.

While ImmunityBio has suffered, the opposite played out with eXp World. Subscribers who followed our advice sold a portion of their shares for an 859% gain seven months later. And we closed out our entire position in August 2022 for a total return of 293%.

2024 has been full of the good and the bad. And during volatile times like today, you can't afford to fall victim to the ugly side of corporate management.

That's why you should keep your eyes peeled for the warning signs of corporate greed... when investing in companies of any size. You can do your own version of our fundamental forensics analysis.

Look for red flags like related-party transactions that line insiders' pockets, frequent capital raises, and even illegitimate headquarters locations.

All it takes is a little extra scrutiny. And that insight can mean the difference between huge losses and astronomical gains.


Joel Litman

Editor's note: Joel says avoiding risky companies is especially critical now. That's because a specific, disruptive event is set to move $10 trillion – and more than half the U.S. stock market – in the weeks ahead. The last time it happened, dozens of stocks crashed 20% to 90%. Find out how to protect your portfolio from this wave of volatility – and even position yourself to profit... Get the full story by clicking here.

Further Reading

If you want to know whether a company is actually looking out for you, take a look through its compensation plan. This information is readily available to the public. And it's one clue to where a company's true loyalty lies... Read more here.

"Not all CEOs will have their shareholders' best interests in mind," Dr. David Eifrig writes. Growth is good. But it's a problem when management chases growth at all costs. That's why you should always know what leadership values most before you invest in a stock... Learn more here.