The Troika Of Ebola Speculation

In the last week we have witnessed a few low-float stocks become Ebola speculation targets as the first confirmed case in the U.S was announced September 30th, 2014. It is fascinating to watch these narratives unfold and low-float momentum plays be ignited as pools of capital cohesively and strategically buy-in. Understanding how the market operates, how media cycles affect expectations and how market participants influence each other asymmetrically are key characteristic of understanding the manic-depressive nature of Mr. Market.

First you may be asking what in the world is a Troika. It is a harness used for three horses to pull a sled in the 19th century.

[Figure 1: Troika Example]

What is speculation exactly?

Speculation is: “the forming of a theory or conjecture without firm evidence.”


That is exactly the dynamic that seems to be unfolding over the last few days in the personal protective gear makers, Lakeland Industries, Versar Inc., and Alpha Pro Tech Ltd. When a company trades its entire float a few times in one day, it is a sure sign speculation is brewing. Since Oct. 7th, (eight trading days ago) all three of these companies have risen over 150%+ while the float was traded an exuberant amount of times.

Company Float Size
LakeLand Industries (LAKE) 4.2M
Versar (VSR) 8.04M
Alpha Pro Tech (APT) 14.77M

In the last eight days Lakeland Industries float has traded 30+ times and the 30-day average daily volume is now 4.86M shares or 120% of the float. The last example of a low-float momentum theme that is quite similar is Digital Ally, a manufacturer of police cameras. Digital Ally had a 2.24M share float and from Aug. 19th to Sept. 2nd (during the Ferguson fiasco) there was cumulative volume of 114 million shares or 51x the float in 11 trading days. The share price during the period went from $3.70 to $33.50 and is currently trading for $10.60 as of this writing.


The narrative at play seems to be Hazmat suits are needed for the Ebola epidemic, there are bagged shorts in these low-float names and there are concentrated hands holding back supply. The media frenzy does not help and the lack of education behind how the disease is spread (direct fluid contact versus airborne) also fuels the fire. LakeLand Industries put out a PR and the president and CEO Christopher J. Ryan explained:

“With the U.S. State Department alone putting out a bid for 160,000 suits, we encourage all protective apparel companies to increase their manufacturing capacity for sealed seam garments so that our industry can do its part in addressing this threat to global health.” 

And PCI Global VP went on to say…

“There’s a very short supply around the world.  We were able to procure these 276 suits through a medical supply company in California, so we bought them up as soon as we could.”  The suits that were procured and shipped were sealed seam garments manufactured by Lakeland Industries.”

So apparently there were only 276 suits available from Lake Land but 160,000 production volume is what is being construed by the market.

The company jumped from 40 million-market cap to 126 million because they sold 276 suits? Unlikely. What is more plausible, is the expectations changed and the market thinks Lake Land will sell 160,000 suits at 6% operating margin (with no CAPEX) using imaginary production capacity. The selling price would need to also be at the maximum of estimates ($10,000 a suit).

In 2014 FY Lake Land Industries had $93 million in sales, a negative operating margin and a loss of just under $4 million. In the last 10 years they have lost a total of about $4 million.


Does Versar even have Ebola exposure or did speculators mess this one up?

When you word search Versar 10-Ks for “health”, “biological”, “ebola” or “disease”, nothing related is returned. Versar purchased a U.K subsidiary, Professional Protection Systems, ltd that services the nuclear industry. The 2014 sales of the company (bolstered by the Olympics says management) were $2.6 million and included in the Professional Services Segment (PSG). Versar grew $35 million in market cap in 3 days as a result. The argument is that Nuclear suits are a substitute product.


·      The Disposable Protective Apparel segment consists of a complete line of shoe covers, bouffant caps, coveralls, gowns, frocks and lab coats.

·      The Infection Control segment consists of a line of facemasks and eye shields.
These two segments DPA and IC, had combined revenue of $17 million in 2013. The two segments before taxes had earnings of $2.6 million. The company grew $70 million in market cap in the last five days.



These three companies also compete with Kimberly Clark, Cardinal Health, Dupont (Tyvek and Tychem) and 3M, among others. Why didn’t these companies jump 5%+ during the same period (they are all negative since Oct.7th) if they are the most likely beneficiaries of protective equipment sales? Because they do not have a low float and are not easily manipulated.

All of these competitors have much higher production capacity and if Hazmat suit supply was a serious issue we would witness production utilization kick up and suit prices adjust upward in the mean time. These competitors have the working capital to finance the growth of the production capacity and they have the ability to buy any of these speculative companies with less than one quarters income.

I won’t name any names but it is very likely that the same group that was behind pumping up Digital Ally is also behind the pump in these names. I am not here to condemn people for participating in low-float momentum stocks or for orchestrating the rise. What I am doing is shedding light on the fragility of these underlying narratives. Low-float momentum stocks (on the long-side) have 1 similar characteristic each time they run.

1.     It is about supply and demand, controlling a large portion of the float prior to the share price running. As controlling hands (or market makers) are aware of their influence they watch and test the supply/demand strategically through “nibbling” and level 2. (as shorts accumulate, covers are harder to find, increasing price volatility). Low floats are easier to control with fewer dollars, hence the role of supply and demand. Shorts end up trapped and a short squeeze commences. There is also a narrative underlying why the product will instantaneously be in very high demand, whether Ebola, police brutality or 3D printing overthrowing large batch manufacturing.

Pump-and-dump and low-float momentum stocks are interesting to study and remind me of 19th century Wall Street with Jay Gould, Jim Fisk, Daniel Drew and Cornelius Vanderbilt during the railroad mania days. What can be learned here is that price volatility in the short-run is a function of supply and demand of the float, while long-term value is created through return on invested capital exceeding the weighted average cost of capital. This is what Benjamin Graham meant when he proclaimed “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

Ebola won’t disappear overnight and I do want to see the crisis solved as much as everyone else. What will disappear over night is half of the market capitalization of these companies. Which night is up to the market…

Further Reading: A very interesting case study on another pump and dump


Plugging into some Reality: Fair Value of PLUG is 50 cents (Citron)

Citron is out with a new report on Plug Power, a fuel cell company, calling it a cult stock, a dream stock (in dreamland with biotech and 3D printing) and a casino stock. Citron makes a compelling argument of why management is toxic and should not be trusted. Regardless of your conclusion the valuation is hardly justifiable and there can’t be to many seriously long-term oriented shareholders when in one day more than the entire outstanding float changes hands, twice. 

The Reality Of Frictional Costs And The Clash Of Cultures

I was referred to Jack Bogle’s novel, “The Clash of the Cultures, Investment Vs. Speculation,” through a Berkshire chairman letter a few weeks ago and decided to pick a copy up from the public library. In the book, Bogle talks about the importance of mitigating frictional costs (management fees, brokerage fees and taxes) during the investment process. He also goes into great detail about the toxic culture that has been created through the conflicts of interest between hedge fund managers, corporate executives, analysts, salesmen and mutual fund, pension and endowment managers. Much of the book is based on an indexing approach, focused on the long-term value creation of businesses as well as the ethics and fiduciary duty an agent has to the client(s) to act in his/her best interest. 

This is sadly not the case in today’s speculative frenzy of exotic derivatives, high frequency trading, short-term focused managers incentivized by assets under management (AUM), day traders, market timing strategies, actively managed funds and any other speculative “bets” you may think of. As elegantly stated in 1776 by Adam Smith, “Managers of other people’s money rarely watch over it with the same anxious vigilance with which… they watch over their own.” 

The present day industry is built on the cornerstone of marketing, not stewardship, collecting assets, not adequately deploying other people’s capital. How can one tell which fund or manager will outperform in the future? If we could accurately tell, wouldn’t we all be identifying the next Berkshire or Fairfax? Morningstar implemented a new rating system in 2011 using “The 5 Ps” as criteria when selecting a manager. 

People: Thinking about the advantages the manager or team brings to the table in terms of differentiation, experience, demonstrated skill, expertise and how much the manager(s) has invested in the fund. 

Process: Is the manager doing something unique or doing what anyone could replicate? (Mirror funds I believe they are called.) 

Parent: Manager turnover at the firm, the culture, the quality of research, directors, SEC litigation or sanctions, and ethics. 

Performance: The past performance of the current manager: the longer the record the better. What is the strategy and holdings of the fund and how did they perform during different periods, how consistent are the returns and what is the risk profile? 

Price: The fund’s expense relative to the asset size, peer group expense comparison and overall trading costs. 

I do not hold mutual funds, ETFs or index funds as I find the entire investment process very enjoyable and exhilarating. When I am looking at businesses that involve investing in marketable securities I do examine the concentration, strategy and turnover of the portfolio with the most scrutiny. The difference between 1% to 2% annually, compounded over a lifetime, can be truly eye opening and astounding. Using the term of 30 years and a present value of $100,000 we will see the beneficial effects of no-load funds, low portfolio turnover and low management fees. 

At 8% (with higher expenses): $100,000(1.08)^30 = $1,006,265

At 10% (index approach): $100,000(1.10)^30 = $1,744,940

A staggering difference of $738,675 or 73.4% more by mitigating controllable costs. Now imagine 8% reduced by 35% to 5.2% if you decide to trigger taxes annually instead of once every 30 years. You would have $1,134,211 in the latter scenario and only $457,585 in the first scenario of annual tax triggers. These differences used for illustration purposes essentially sum up the difference between annually changing your mutual fund investments versus a long-term indexing approach. Simply stated, taxes and fees shouldn’t be given the cold shoulder. 

Here Are Jack Bogle’s 9 Simple Rules for Investment Success:

1) Remember Reversion to the Mean

This rule is based on the philosophy of “what can’t go up forever, wont” and “what goes up, must come down.” Analyzing long-term winners in the mutual fund business like the Legg Mason Value Trust Fund or the Fidelity Magellan Fund show that under closer scrutiny both actually underperformed the market over a 30-year stretch (1982 to 2012) and the hype of these well-known funds come from short-term sporadic performance that has since fizzled out. 

If you hold mutual funds, read the prospectus. RTM can be simply visualized by a pendulum that is moving from optimistic valuations to pessimistic valuations and back again. What is earned in market returns in excess of what the underlying businesses actually earns will simply be borrowed from the future, based on optimistic speculation from the present. Eating your dessert before your dinner is fine and dandy, until those cooked carrots need to me muscled down. 

2) Time Is Your Friend, Impulse Is Your Enemy 

As briefly outlined above there is large differences between annual capital gains tax triggers and once-in-a- generation tax triggers. Do the math yourself and research the correlation between net fund returns and the turnover of fund holdings; my bet would be the relationship is an inverse one, meaning the lower the portfolio turnover the higher net returns. I also remember reading an article or comment on GuruFocus relating to how often Buffett or other concentrated value investors turn their portfolios. Again, I have no empirical evidence but my guess would be that most successful ones have a turnover rate under 25% and some may have turnover as low as 5% to 15%. 

3) Buy Right and Hold Tight

Relating to portfolio allocation, John Bogle and I seem to have similar views. When it comes to risk profiles and fixed income concentration, age should be a large factor. The easiest heuristic to remember would be 100 – (Your Age) = Equity Exposure. Personally, I like to take the sum and multiply it by 1.1 as I have a strong stomach for volatility, increasing my exposure to equities. Relating to the equity exposure portion it is up to each individual investor’s preference to dictate what the holdings should consist of based on personal risk profiles. 

4) Have Realistic Expectations

In the book an elaborate metaphor is used comparing an “Investment Bagel” to a “Speculative Donut.” The Bagel is nutritious and represents the dividend yield plus the earnings growth. The donut is sugary and it tastes great but is terrible for you repetitively in the long run. Having realistic expectations will help thwart the inclination to speculate for larger returns and keep you satisfied with returns in excess of a few hundred basis points of the S&P 500 (or another preferred benchmark). Remember the power of compound interest: A few percent can and will make all the difference. “In the short-term the market is a voting machine, in the long-run it is a weighing machine.” 

5) Forget the Needle, Buy the Haystack

I do not entirely agree with this statement but for the people who do not have the time nor the inclination to research and “turn rocks,” indexing is the best alternative. Because (as most people that understand math would agree) everyone that is involved in the market is the market,proactively and reactively placing bets on new information received that represents each individual’s perception of the probability of outcomes that may occur. Because we are the market,at least 50% of the participants must underperform the market. If you do not believe you have the correct psyche, skill or amount of time it takes to outperform the market (over a lifetime average), it may be best to index your returns using low-cost approaches. As Munger once said, the market in a (very) simplified state, is a parlay horse track, actively adjusting spreads based on participants’ expectations of the outcomes. 

6) Minimize the Croupier’s Take

This cannot be stressed enough! If you understand the effects of compound interest, even 0.50% over a lifetime can make a noticeable difference. You need to be proactive in reducing management’s take, the government’s take and the broker’s take of your hard-earned dollars. No-load funds with low annual turnover and a low MER are a great place to start. It is absolutely ridiculous that expenses attributed to marketing can be eliminated from an investor’s net return. The sole purpose of marketing funds and institutions is to increase AUM or the fees that the portfolio managers can collect and is in no way beneficial to an individual shareholder who is subsidizing this service. (One could argue it is actually harmful due to the law of large numbers.) 

Whatever happened to fiduciary duty and stewardship or am I just a naïve young kid? Agents must act in the best interest of the client and should only be given one chance. We are dealing with people’s life-long earnings here: Show some respect. Keep an eye on those fees and do all you can to minimize taxes. “The best holding period is forever.” 

7) There’s No Escaping Risk

A capital markets line sums up this statement and with greater reward comes greater risk. This is not always the case (as measured by risk adjusted returns) but it is a general rule of thumb. Embrace risk but only to the point where you are still comfortable sleeping at night. If this is not the case “sell down” or change your portfolio exposure to a more comfortable level. 

8) Beware of Fighting the Last War

Fighting the last war is related to the bias the immediate past casts on our perception. A brief example of this is how skittish investors are to the thought of a large-scale decline in the market similar to 2008 through 2009 or over-valuation of the late ’90s. We fear events after they have happened, essentially driving with the rear view mirror. Yikes! 

9) The Hedgehog Bests the Fox

The Greek poet Archilochus once said, “The fox knows many things but the hedgehog knows one thing.” The fox, that is sly and astute, represents the institutional investors of today, that know (or believe they know) about the complex market and strategies that will outperform. While the hedgehog, which curls into a ball with an almost impenetrable spine, knows only one thing: Long-term investment success is built on the cornerstone of simplicity. The simplicity is known to be the magic of compounding returns and low frictional costs, keeping costs to a minimum, while efficiently allocating capital. 

“Compound interest is the eighth wonder of the world. Those who understand it, earn it. Those who do not, pay it.”