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What is Torpedo Watch?

Torpedo Watch™ provides investors a disciplined way to identify and track companies that are going to underperform and outperform the market. Our proprietary rating system provides a snapshot of a company's fundamentals each quarter and identifies trading opportunities both on the short and long side. Large money management firms typically hire Ph.D. quantitative analysts or "rocket scientists" to do this work and develop research that will accurately provide warning signals which enable investors to buy winners and sell or short the future losers.

This is the first time investors have been able to get direct access to such high-level institutional research without having to pay tens of thousands of dollars. At last, individual investors have someone in their corner to tell them how companies are really performing fundamentally by looking at how much cash and earnings are actually being generated. Individuals no longer have to rely on sometimes unreliable financial reports or analysts to tell them how companies are performing and whether or not problems are evident. Doing this analysis requires much more work than most investors are able to do on their own. In the aftermath of Enron and WorldCom it is time to put the odds back in favor of individual investors and generate great investment opportunities month after month.

We are committed to adding significant value to your investment decision-making as we have done for countless institutional investors. Investors who follow Torpedo Watch™ will be able to cut down on the number of losing stocks in their portfolio. They can also make money shorting stocks if they fully understand these indicators of the five causes of torpedoes. Similarly, companies that are identified with high quality indicators tend to outperform the market and offer investors an opportunity to make money owning the shares. As a subscriber, you will always have access to our ratings on five of your stocks as well as our reports twice a month. It is with great pleasure that I invite you to become a subscriber to Torpedo Watch™.

Our Philosophy

The Torpedo Watch™ philosophy is simple: Stock prices will eventually reflect the fundamental performance of the company. While analysts and company management may be talking a great story or reporting misleading financials, our rating system is designed to cut through the spin and find some measures of truth which will determine future prices. This information is available in published financial statements. None of these indicators we use involves a single data point provided by analysts, so it is strictly independent of analyst views.

Torpedo Watch™ is designed to help improve investment performance by identifying stocks whose fundamentals are deteriorating by selling them (or shorting them) before prices fall. The Torpedo Watch™ process is similar to an annual physical examination when a doctor measures your blood pressure, heart rate, blood chemistry, listens to your breathing, and takes x-rays and other pictures required.

We apply the same principles to companies. Torpedo Watch™ can determine whether the stock may be sick or coming down with a problem that may jeopardize its financial health. Torpedo Watch has identified fives causes that may result in a warning in our rating system:

• Overvaluation
• Aggressive accounting
• Deteriorating financial condition and the hiding of liabilities
• Significant change in operating performance due to industry fundamentals or the company's competitive situation
• Bad acquisitions

Overvaluation becomes an issue when the stock price gets ahead of its fundamentals. This is often due to investors believing that the company fundamentals will keep growing at a faster rate than its competitors, markets and/or its industry. The downward spike in price after overvaluation has been achieved can be sudden and often violent, significantly damaging portfolios.

Aggressive accounting has become a serious problem in recent years and is often missed by investors because it requires sweat and toil to decipher the financial statements.

Deteriorating financial conditions can be present even if a company is showing strong revenues and earnings. Often it may seem everything is okay, but the cash is draining away and balance sheet is piling up with weaker assets. The failure to disclose off balance sheet items would fall into this cause.

A significant change in operating performance has caused many a stock price to fall. A company which sees its competitive advantage taken away will often be forced to lower both its gross and operating margins to continue to maintain its market beachhead. Likewise, the company may be forced to drop prices causing revenues to fall.

Bad acquisitions are a by-product of the 1990s when companies believed they could purchase another company and improve profits due to the "synergy" of one combined entity. Many times, these were bad decisions that brought down stock prices.

We have organized our torpedo warnings into five categories that combine all the 50 measures we look at in reviewing a company's health:

• Investment Quality
• Cash Flow Quality
• Earnings Quality
• Balance Sheet Quality
• Valuation

Investment Quality measures the operating efficiency and profitability of the company and includes indicators such as turnover, margins and returns.

Cash Flow Quality examines the amount of real cash flow the company generates from its business by adjusting for non -recurring events, such as acquisitions or meeting liquidity needs and other items.

Earnings Quality measures the durability of reported earnings and what portion of those earnings is "core" to ongoing operations and likely to be repeated. This quality measure excludes one-time items and adjustments not part of ongoing revenues and considers the amount of cash supporting it.

Balance Sheet Quality measures the changes in the amount of key short-term assets and liabilities. This is where we closely monitor a company to see if they have "cookie jar reserves" hidden for a rainy day that can be used to enhance earnings.

Valuation enables one to observe whether a company's stock price has gotten ahead of itself, by comparing it to the market and the industry in which it operates. This is not a useful measure by itself as companies can stay overvalued for a long period of time. However, when combined with the warnings from the other four quality measures listed above, it is better than sonar in avoiding torpedoes.

For buy ideas, our reports identify companies whose five measures are strong, not weakening as in the case of the potential torpedo companies. These are companies with strong fundamentals whose price is not out of line. Each month we will recommend one or two long ideas to compliment Torpedo Watch companies to avoid and to short