Jim Chanos on Idea Generation Through Pattern Recognition

“…we’ve tended down through the years to see that a lot of our ideas fit certain broad themes.” —Jim Chanos

Podcast: Jim Chanos on the Art of Short-Selling

A few days ago I was lucky to find another great interview with Mr. Chanos, this time from FT Alphachatterbox released on April 25, 2016. In this interview Jim Chanos is asked a question about idea generation and pattern recognition:

Getting back into the general sense of where ideas come from, are there kinds of patterns that you look for? What are the sorts of things, whether it’s capital structure of a company or management that sets off alarm bells?

Answering this question Jim Chanos provided a list of six broad schemes that he admits a lot of Kynikos Associates’ investment ideas fit into. The six schemes are:

  1. BOOMS THAT GO BUST. “…we’ve tended down through the years to see that a lot of our ideas fit certain broad themes. One I mentioned is the booms that go bust, where you just get these credit-driven asset manias and the asset can’t service the debt. Usually that ends in tears.”
  2. TECHNOLOGICAL OBSOLESCENCE. “The internet’s been a great wealth creator, but it has destroyed lots of business plans and lots of moats, and we keep our eye out. And that’s, for us, an ongoing source of ideas. It’s amazing how the analog-to-digital revolution just continues to find new businesses to decimate. And we’re mindful of that. It’s the Schumpeterian view of capitalism.”
  3. CONSUMER FADS. “…you see Wall Street over and over and over again just extrapolating out single product companies with hockey stick growth, whether it’s George Foreman Grills or Nordic Tracks or Cabbage Patch Dolls or FitBits or whatever it might be. ‘This time it’s different. Everybody’s going to have five.’ And it rarely is.”
  4. GROWTH BY ACQUISITION. “Another area would be growth by acquisition. We’re just drawn like moths to the flame, I guess, to companies in crummy businesses that decide to tell the Street that they’re actually growth companies by buying the growth. Typically this leads to the temptation of playing acquisition accounting games in terms of valuing the assets and/or spring-loading by having the target companies hold off business in the interim period between the announcement of the deal and the closing of the deal so they look better once you fold them in. And so we love those kinds of stories, the rollups, or as they’ve been deemed, the ‘platform companies’.”
  5. ACCOUNTING GAMES. “Then there are just pure outright accounting stories, where we just find a company that’s just completely playing legal or illegal accounting games to obscure the reality of what’s going on.”
  6. SILLY TRADES. “…then finally, any time we can sell $1 for $2 because the market gives us some silly trade, we’ll do that till the cows come home.”