Learn the secrets of reading SEC filings

Readers of my blog know me as a successful day-trader. However, before I had heard of Timothy Sykes and turned to day-trading, I had an incredible run as a fundamental short seller of penny stocks. I amassed a large amount of money by betting against fundamentally flawed companies after doing in-depth research. Now that I have a DVD coming out with Timothy Sykes on how to read SEC filings, you can learn my secrets for doing fundamental research using those filings. Pre-order the DVD now and save $100! [Note: the DVD is sold exclusively through Tim Sykes’ web store; it is entitled “Read SEC Filings”]

Below are my returns (time-weighted IRR and mark to market profit, as calculated by Interactive Brokers) from my main brokerage account when I started my fundamental short selling:

September 2007:  +24.85% , +$40,756.01 (pdf statement)
October 2007:  +17.15%,  +$37,497.50
November 2007:  +6.39%,  +$17,269.27
December 2007:  +2.48%,  +$7,287.55
January 2008:  -0.29%-$528.27
February 2008:  +19.48%,  +$71,491.06
March 2008:  +16.51$ , +$71,421.28
April 2008:  +4.59%,  +$22,387.36
May 2008:  -79.88%,  -$63,899.06 (note: in May I transferred most of my money to another account at Interactive Brokers, so the percentage loss is not meaningful)

Net profit over period: $203,682.70

While I was doing some short-term trading and value investing as well, most of the profits and losses from this time period came from my fundamental short selling. In fact, I was so good that I only suffered a meaningful loss on one position, although unfortunately that was my largest position ever. In May and June I was forced to cover that position due to a forced buy-in, and I received forced buy-ins in other stocks I had shorted, including KYUS and MNLU. I abandoned my fundamental shorting strategy after concluding I could no longer rely upon obtaining long-term borrows to short stocks. But while it lasted, I made a lot of money doing fundamental short selling, utilizing the skills of reading SEC filings that I had acquired.

I present a few of my favorite success stories below. I urge you to consider them and decide whether you might benefit by learning how an experienced trader / investor / short seller such as myself investigates companies to both dig up the dirt and find hidden gems. I have an instructional DVD now available for pre-order ($100 off!) that I am producing with Tim Sykes. There will be about 5 hours of Tim Sykes explaining and giving examples of how he researches companies and 5 hours of me doing the same. Buy the DVD by Friday, November 6th and you will also get to attend a free webinar where you can ask questions and learn more.

Fundamental short selling success story: Noble Roman’s

Perhaps my favorite of those companies, Noble Roman’s (OTC: NROM), had engaged in a rapid expansion using multi-level franchising (they would sell the rights to franchise their brand within a specific geographic area to ‘area developers’), and the stock surged as a result of the increased revenues from those agreements. But after digging into Noble Roman’s SEC filings and analyzing the numbers myself, I realized that most of their revenues were coming from the area developer agreements and they were running out of areas to sell! Furthermore, their franchisees were failing at an alarming rate and new restaurants were not being built at the rate they should have been built. I called out Noble Roman’s in a now-famous blog post, Noble Roman’s Strategy Falls Flat, saying:

All in all, things do not look good for Noble Roman’s stock or for its business. In my realistic scenario, the company is priced at over twice its intrinsic value. In a worst-case scenario most of the new franchises will never be sold, the area development agreements will flop, and Noble Roman’s will struggle to earn $1 million per year. In this scenario the company’s stock price could easily fall 75%.

When I published that post, the stock was at $2.48. I had taken a short position of about 27,887 shares at an average price of $4.67 a couple months earlier (I had first started accumulating my position in early August 2007). The stock dropped steadily as more and more bad news came out and I covered in January 2008 at an average of $1.85, making $78,692 (60.4%). The stock continued to dive after I covered as my prognosis about the company was proven almost entirely correct. Afterward, I was quoted in two articles by Cory Schouten of the Indianapolis Business Journal (Noble Roman’s is based in Indianapolis).

While anyone can look through an SEC filing, it takes expertise to really understand them and to know what to look for. Pre-order my DVD and you will be better prepared to research and understand companies and profit from that knowledge.

nrom

Fundamental research can give you a huge advantage

Noble Roman’s was not an isolated case. I was also proud of the research I put into my articles on Remote MDX (OTC: RMDX). I wrote two good articles on August 20, 2007. Noted short seller Andrew Left of Citron Research was late to the party, writing about the company in December 2007. I also beat noted micro-cap investigative journalist Carol Remond, who wrote about the company in February 2008. I made over $47,000 short selling Remote MDX, despite being way early.

My research was useful even when I was not short selling. I wrote a short piece about H2Diesel (OTC: HTWO), which has since changed its name to New Generation Biofuels (Nasdaq: NGBF). I did only brief analysis of the company’s SEC filings and concluded that the company’s product had little potential. I wrote a negative article on my blog in October 2007 that was syndicated on Seeking Alpha. The day after Seeking Alpha published my article the stock dropped 50% and never again reached the price it had been at before my article was published. Maybe if the morons who had invested in H2Diesel had read and understood the company’s SEC filings they would not have lost money investing in the company.

ngbf

Short selling an unknown bank into oblivion

In June 2008 I acquired a short position in Silver State Bancorp (SSBX at the time, now SSBXQ). While I covered some of my position at a small loss, I ended up building a total position of 3,700 shares short by late July, at prices ranging from $2.44 to $1.52. In early September 2008 the bank was closed by the FDIC. I covered my short position on September 11, 2008 at $0.06, for a net profit of $6,839.39.

How did I know that Silver State Bank was toast? For that matter, how did I know that the much larger Downey Financial (DSL, now DWNFQ) was a dead bank walking? [The link is to my blog on Motley Fool CAPS, which I no longer update.] I knew because I had not only read through the financial statements of those banks but I had also skimmed over the SEC filings of literally hundreds of other banks, and I had come to understand the fundamental problems with the loans these banks had made.

Not just for short selling

On September 5th, 2006 I bought 620 shares in a tiny biotech equiptment maker called Stratagene, paying $4.90 per share. I had seen something in one of the company’s more mundane SEC filings that indicated that the company was worth a lot more than its market value. Eight months later I sold my shares for $10.87 each and reaped a 122% profit ($3701.65 profit). I could have sold out months earlier after Agilent (Nasdaq: A) offered to buy Stratagene, but I held out to make a few extra cents per share. How did I know that Stratagene stock was worth so much more than I paid? Buy the DVD and find out!

Two ways to learn to read SEC filings

If you do not want to buy a $497 DVD (remember, it is only $397 during the preorder period; order it by November 6th to get free access to a follow-up webinar where you can ask questions), I encourage you to learn how to read SEC filings on your own. It is not that hard, although it will take a lot of time. First you must buy a few books on the basics of accounting, then read through hundreds of annual and quarterly reports, and finally read hundreds of academic finance articles on key indicators in SEC filings. Then, after hundreds or thousands of hours of reading, you would know as much as I know about how to interpret SEC filings. Or, if you want to save yourself a lot of time, buy my 10-hour DVD and you will learn most of what I know as well as most of what Timothy Sykes knows about reading SEC filings in a lot less time.

Disclosure: No positions in any stocks mentioned in this post. The SEC filing DVD is being produced and sold by Tim Sykes’ company Bullship Press LLC and I will receive royalties on every sale. I will also receive a commission for every DVD bought through my affiliate link to Sykes’ web store. To see more details on my relationship with Sykes, please see my disclosures. I have a disclosure policy and you can find all my disclaimers there as well; those disclosure & disclaimers are incorporated by reference into this post.

0 thoughts on “Learn the secrets of reading SEC filings”

  1. Michael, that’s pretty awesome. You really have explored several types of trading that have been profitable for you.
    I will order a copy though it will be later than Friday for sure.
    IUSA has taken off, did you get in.

  2. Yeah those guys normaly take larger positions and wait for the swing. They build positions on the way down and normaly have positions built in the Bull opposite while they are building one in the short ETF.

  3. LUNA might be a good short, I made money off of it in Sept. Would like to see more volume and a little higher price before I get in.
    No news that I can see.

  4. It’s amazing to watch a technical breakout happen like with SHS, it’s almost like magic how it must light up on so many screens at once then the buying starts.

  5. qb, I do believe that was a pure technical breakout my brother. When I found it it had only traded around 300k shares and quickly doubled. I found it around 8.10 or so, it looked good with low volume. I’m still to chicken shit to buy these though, I will get the confidence I need soon enough. Just watching is enough for now, I have an addictive aggressive personality so I really have to be careful with trading.
    I hope someone got in on it though, maybe reaper will mention it in his re-cap and I can win some of my ducks back that I lost last week.

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