The case of the "suspect" suspect, or how to handle disconfirming evidence (#3)

Credit Acceptance Corp. could be a long buy or a short sale candidate.

How an investor handles disconfirming evidence plays a large role in their returns over time. As the theory goes, you should do what Darwin did and write down the evidence that goes against your thesis right away before your brain has a chance to play tricks. This all sounds well and good in theory but in practice it is harder to do. I came across such a situation with Credit Acceptance.

Credit Acceptance Corp. is a subprime auto lender. The company first came onto my radar when I screened for banks with high returns on assets and insider ownership. It stood as an outlier, but I chanced to look at the annual report.

What I found was a very well-written letter to shareholders penned by its CEO. The letter detailed the business clearly and highlighted many key metrics which its management used to assess performance. To my delight, I found CACC mentioned in a book about good companies and good management teams. What’s more, an investor I follow was on the board and had owned stock in the company for over twenty years.

Having seen enough to give me a general indication of a good opportunity I decided to highlight it in this month’s issue. I downloaded fifteen years’ worth of 10K’s and set to work getting a sense of the business and its history.

Then a Watchlist reader alerted me to the short case against CACC. In fact, he had a small short position himself. Now, part of my research always includes looking at short interest, major respected shorts in the stock now or in the past, and any short reports available on the company. I’m grateful I had this information sooner as all indications were this was a very good company I might consider purchasing immediately.

My conclusion is that CACC might be a company worth putting on the Watchlist. I just don’t know enough yet and I need to do more digging.

Subscribers to the paid Watchlist Investing Newsletter can read about CACC in-depth, which includes ten years of summary financials and capital allocation history.