At some point in their downward journey to zero, almost every single dead company walking I have shorted has been a "cheap" stock on paper. Failure can be a slow-moving process, and even very troubled firms can show positive signs like decent cash flows or low stock multiples. These indicators often tempt value-oriented investors who fail to pay attention to wider secular shifts. I always like to remind people that the number of pay phones in America didn't peak until 1999. By then, cell phones were already well on their way to making those devices obsolete. But that didn't stop all sorts of respected Wall Street analysts from recommending pay phone company stocks. Like most investors, I spend a lot of my time buried in financial reports. But sometimes it pays to pull your head out of spreadsheets and projections long enough to ask yourself a basic question: Will this company even exist in five or ten years?



*A bonus symptom: insider selling when a stock is at or near 52-week lows.



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Investors tend to overreact to insider activity. It can be a useful indicator, but it's hard to gauge exactly why most executives or board members buy or sell their companies' stocks. They might be cashing out because one of their kids just got into an expensive college. However, if a stock is making consistent new lows at the same time as top insiders are bailing, something is definitely rotten in Denmark. This is a very rare occurrence. Out of the hundreds of companies I study a year, I might come across two or three instances of it — and it definitely grabs my attention when I do. If that same company is suffering from one or more of the other symptoms I've described, there's a good chance that I'll pick up my phone and short its stock.



Commentary by Scott Fearon, the founder and president of Crown Capital Management. He is also the author of "Dead Companies Walking: How a Hedge Fund Manager Finds Opportunity in Unexpected Places," which chronicles his 30 years of experience in the investment management industry.



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