- Rule #1: Avoid any company if the company's CEO responds to a legitimate question with profanity and/or personal attacks. This applies double if the profanity occurs during a quarterly conference call. Consider shorting the stock or buying out-of-the-money put options.
Examples: - Patrick Byrne (Overstock) responded to certain allegations by a research firm suggesting that the authors should be "be beaten, f---ed, and driven from the land."
- Jeff Skilling (Enron) swore at an analyst who asked why Enron couldn't produce a balance sheet and cash flow statement along with the income statement at the time of the quarterly conference call.
- Rule #2: Avoid companies that engage in transactions wildly unrelated to their core business.
Examples: - When Delta filed for bankruptcy both EDS and Disney disclosed writedowns related to aircraft leasing arrangments with Delta. EDS is a business process management company and Disney, of course, offers media and family entertainment. Neither company should, despite their disclosures of the leases, be in the business of aircraft leasing. Last time I checked the synergies between running a company that creates animated films for the pre-K set and vetting leasing arrangements with bankrupt companies were fairly low.
Note: Rules are not ranked in order of importance.