Why 'Doctors & Dentists' are an Overlooked Aspect of Due Diligence

Aug 23, 2018

Matt Conger

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Let's talk about shareholder bases. At Cadence, we've been trading messages on Slack on what the activist revolt at Campbell Soup means. We also shared notes on Eddie Lampert's recent bankruptcy at Sears. Our discussion in both cases revealed an oft-overlooked part of due diligence: the fate of these companies is often tied to who owns the stock.

So for our clients conducting due diligence, and our linguists and transcribers who are supporting those due diligence efforts, let me offer my thoughts on 'doctors & dentists' and why this is so important.

Sentiment versus fundamentals

Investors will often spend hours researching companies and dissecting their fundamentals. They will use numerous metrics and ratios, comparable valuation, or even run complex models in trying to assess if an investment will pay-off.

Despite most investors’ best efforts, nothing is fool-proof; what may seem like a bargain can often turn out to be a dog.

After all, the price of a stock is determined by the market, which is made up of a body of investors. Therefore, knowing the shareholder base of a stock can serve as a critical piece of information to help determine if an investment is the right one.

There are many types of shareholders that can comprise the shareholder base of a stock. Understanding that base is essential because it can give a potential investor a keen insight into the type of institutions the stock attracts. Is the shareholder base made up of fast money hedge funds? Long-only plain vanilla mutual funds? Activist investors?

There's a hedge fund in my soup

This chart shows a huge disparity in the shareholder base of three well-known companies (Tesla, Google, and Apple), and two lesser-known companies:

There's a couple insane things you can see in this chart:

1. Whoever runs (or founded) Campbell's still owns a LOT of the company. Campbell's so-called insiders own 40%+ of shares, whereas at Apple they (incredibly) own less than 0.1%.

2. Hedge funds make up nearly 10% of the ownership of Campbell and over 20% of Mellanox. That means unlike passive institutional investors, if they want to impose change, they (most likely) have the voting power to do so.

3. The green 'Other' bar owns a lot of Apple. Who are these people? Keep reading and I'll explain.

Fun fact about Campbell's Soup. The largest hedge fund which owns Campbell is Daniel Loeb’s fund, Third Point LLC. They are an activist investor who believes there is hidden value in the company that changes in the board of directors and management may help to reveal, thus increasing the stock price. His fund took the incredible step of creating a video slamming the company and its current management team.

Long-Term vs High Turnover investors

Consider Tesla (which you've heard of) and Mellanox (which you probably haven't). Both have highly concentrated shareholder bases, but one of them is more company-friendly than the other.

Tesla Inc. (TSLA) is often thought of as cult-stock, which brings forth images of obsessed and crazed investors that will do anything for their beloved company. However, contrary to popular belief, the shareholder base is heavily concentrated to just a few investors. The top 8 investors (both insiders and institutions), including Elon Musk, own about 60% of the outstanding shares. The base is largely made up of well-established, long-term institutional investors or mutual funds.

Additional reports suggest the Saudi Arabia Public Investment Fund owns a 3 to 5% stake in the company and Tencent Holdings Limited owns around 5%. If true, this means that as much as 70% of Tesla’s stock is owned by only 10 investors, all of which can be considered stable and long-term.

By contrast, let's talk about the fate of Mellanox (MLNX), a stock which has risen 85% over the past 52-weeks. It has a fast-moving shareholder base. The top 8 shareholders in this company control just 32% of the shares. These top investors also tend to have high turnover rates, suggesting there isn’t a long-term commitment from its shareholders to the company, and that they will likely bail on the stock should the investment or the fundamental turn sour.

Doctors & Dentists

Finally, I showed you that well-known companies tend to have a large 'Other' component to their shareholder base. Who are these investors? They are you and me. These so-called retail investors often own $100-$10,000 of shares in any given company, whereas institutional holders have many, many, more zeroes on the equivalent number in their portfolio.

Retail investors are sometimes referred to as doctors & dentists, since people in these professions are generally thought to be:

a) Wealthy enough to dabble in stocks

b) Not sophisticated enough to outperform the market

As a result, the term itself 'doctors & dentists' has become a bit pejorative, so exercise caution if using or encountering it.

On the whole, the more well-known a stock is, the more likely it is to attract retail investors. I'll leave it to greater minds to say if this is a good or bad thing. Personally, I love being a retail investor and armchair analyst. I had a fun conversation in the office the other day about why the runaway commercial and critical success of Red Dead Redemption II barely moved the share price of its publisher.

Resources to help you

Hopefully I've convinced you about the importance of knowing who your neighbors on a cap table will be. Here are some free resources that I've used to quickly gather this information:

  • U.S. 13F filings: These are quarterly, mandatory disclosures for large institutional investors to report what shares they own. You don't need to read the filings usually, but you should instead find a service that aggregates them. One example is...

  • WhaleWisdom: This is a great site which aggregates 13F filings. These are by no means timely (the institutional investors wait till the last minute often to file these, as they don't want their trading positions to be disclosed a minute sooner than necessary). The free version does the job.

  • NASDAQ and other exchanges: Most stock exchanges will aggregate this information as well as try to layer on holdings by company executives.

  • Crunchbase: Well-known in VC circles, this can also be a good, free resource for finding the shareholder base of privately held companies.

A final reminder

An investigation of the shareholder base may very well let an investor know if a stock is even worth the time to do the necessary due diligence to make an investment decision. If the current make-up of the shareholder base is unimpressive or consistent of shareholders that do not fit your investment style, it may be a quick and effortless way to determine if you should move on or explore the company any further. In future editions, we'll try to supplement this article with resources outside the U.S. to help with your due diligence.