Hatchet Job

Posted on January 13, 2012 by David Laidlaw

Short sellers are often vilified by company managements and Wall Street’s public relations arms.  However, short sellers are frequently the canaries in the coal mine that add valuable market information regarding the securities that they bet will decline in value.  Short sellers were the first to uncover many scandals that subsequently produced billions in losses for the investing public.  For example, Michael Burry’s short of the mortgage-backed securities market through purchases of credit default swaps provided valuable information that the housing market was poised to deflate (see Michael Lewis’s book The Big Short).  However, many short reports add nothing to the marketplace since the research is so shoddy.  

One such report appeared during the 4th Quarter on Bio Reference Laboratories, a medical testing company held in our small cap portfolio.  Released in two parts by The Street Sweeper, the report detailed concerns about one of the company’s largest tests and Bio Reference’s business ethics.  While questions about the utility of the company’s pap smear test may have been valuable if the information were accurate, many of the allegations were almost comedic in their irrelevance.  For instance, the Street Sweeper report questions the integrity of the auditor, Moore Stephens, by maligning any company based in New Jersey:

In the past, Moore Stephens catered to a couple of particularly notorious clients in New Jersey (the same state that Bio Reference calls home) and came under fire from government authorities back then, too.

Amazingly, these reports managed to cause Bio Reference’s share price to decline by 40% from November 1st when the first report was issued to the end of the month (almost 3 weeks after publication of the second report on 11/10).  Subsequently, the stock has recaptured more than half of its losses during the month of December as a more rational valuation has been assigned to the stock.  

All information about a company that flows into the market to determine a price for a particular stock is not created equal.  As fundamental analysts, we consider that which we determine relevant and discard that which we view as noise.  Even though dramatic reports can have a large initial impact (especially on a thinly traded stock) only those that provide valuable information will have a lasting effect on a stock’s price.