A classic crypto crash, a "bargain" stock that was anything but, and tales from the financial crisis of 2008. The memories will likely send chills running down the spines of most investors. The rising panic as stocks fall and the desperate rush to sell. For Halloween, we asked some foremost financiers and voices of reason to dig deep into the depths of despair, to relive their worst investment horror stories and share the lessons they learned.
Tales from the Crypto
By Andrew Willis, Content Editor, Morningstar Canada
In the run up to the bitcoin peak of December 2017, I had noticed a trend of companies adding the word "blockchain" to their name, with massive gains following. Many may remember Long Island Iced Tea Corp’s (LTEA) transformation to “Long Blockchain Corp.” (LBCC) and the same-day 200% surge in stock price that followed (and the de-listing, SEC and FBI investigations that also followed). I felt something was gimmicky about the blockchain-name-change thing but thought I could be clever and profit from a few-hour lead and sell before the hype dwindled.
I set up my media scanner and some Google Alerts and sure enough I got a press release that renewable energy provider Transeastern Power Trust (TEP.UN) would be changing its name to “Blockchain Power Corp” (BPWR) and had secured a $40 million private placement. I noticed that it had already doubled in the weeks before that announcement, but I went ahead and made a (thankfully small) bet around $0.55 a share. Turns out those gains before the announcement were pretty much the only gains to be had. The stock did rise to around $0.65, but I made the critical error of losing sight of my strategy after looking into their business model. Unlike the iced tea company, this company had a healthy dividend and a plan to mine bitcoin with the low cost of the energy they produced themselves with their own wind farms. I thought that even if the bitcoin bubble burst, they would still have a decent business in background. Well, the bubble did burst, and what followed was a decline to around $0.13 today.
What I learned:
I managed to maintain the discipline to avoid panic selling when the stock touched $0.06 earlier this year, which was a good learning experience. Ironically, the name of the stock served itself as an important reminder to take hype with a grain of salt, as it sat near the top of my alphabetized portfolio and would be the first thing I saw every time I looked at it. Earlier this month, the company made an announcement it was making yet another name change, this time to Jade Power Trust (JPWR.UN). I don’t understand the choice of name, but I guess the investment gods have decided that I no longer need the immediate shaming every time I look at my holdings.
The Haunted House
by Dan Kemp, Morningstar Investment Management
While I have made countless investing mistakes, in most cases the impact has been fairly minor as I have primarily missed out on gains rather than experienced losses. The most significant of these is that I didn't get around to buying a property until recently and so am now facing a large mortgage on a property I could have bought 15 years ago at a much lower price.
What I learned:
While there are many reasons why I didn't buy a property earlier, this experience has reminded me that long-term investors benefit from being optimists rather than pessimists. However, this does not negate the importance of always focusing on valuation and demanding a margin of safety.
The Valeant Massacre
By Greg Taylor, Chief Investment Officer, Purpose Investments
Investing in growth companies in Canada can be terrifying in itself. There aren’t many of them and when one catches global investor attention, these stocks can move very far and very fast. But when it turns, look out below. Valeant (now Bausch Health (BHC)) briefly became the largest company in Canada in 2015 as the healthcare roll-up theme caught on. It ended up being more financial engineering than real growth, but investors couldn’t get enough of it. It dominated the performance of the then resource-focused TSX and if you didn't own it, you underperformed. And then it all ended for the roll-up stories and everyone hit the sell button. The stock fell from more than $300 to under $50 and no one wanted to admit they even knew the ticker. In the end, the company had a complete metamorphosis, changing everything right down to the name. It’s still around, but nowhere near as dominant as it once was.
What I learned:
Don’t get caught up with the masses. Markets consistently do what makes the most people wrong and one of my biggest fears is being too close to then consensus. Being a contrarian hasn’t worked as well in the past few years, but it is an important skill to have and something to keep in mind when investing. Once the consensus trends begin to change, if you aren’t early you will be forced to sell at the same time as everyone else when there are no bids.
The Taxorcist
By Michael Dorfman, Portfolio Manager & Investment Advisor, BMO Private Wealth
The scariest lesson learned in my 30-plus year career happened to a client. He owned a big position in Bell Canada (BCE) in the 80s, which spun off shares in Nortel, the digital technology company. Nortel began a meteoric climb during the great tech/internet bubble of the late 90s. In July 2000, Nortel shares hit a peak of C$124.50, providing my client a market value of $500,000 with a cost basis of only $25,000. I practically begged him to allow me to sell some shares to reduce the concentration risk, but he argued this would cause too much capital gains tax.
What I learned:
I lost that battle, and he finally sold after the shares had sunk precipitously prior to eventual bankruptcy. The moral of this scary tale is to not avoid taking a profit due to concerns about paying tax. This client, ironically, ended up not having to worry about capital gains at all!
The Washington Mutual Project
By Syl Flood, Chief Content Strategist, Morningstar
I’ve been a stock investor since the mid-1990s. I survived the dot com bust by not having a significant amount of my personal assets in stocks at that time, and continued investing in stocks through the 2000s.
As the financial crisis was simmering in 2006 and 2007, some financial services companies began to look like bargains as fundamentals began to deteriorate. One that looked really cheap was Washington Mutual. I was heartened by the fact that several value-oriented US mutual fund portfolio managers that I respected owned a significant amount of the name. I used only Morningstar research to make the decision to buy.
Its peak market cap had been $40 billion. Part of my thought process in buying the stock had been: when things return to normal, its market cap will, too.
Needless to say, the investment didn’t pan out. The US FDIC took over Washington Mutual on September 25, 2008, and JPMorgan (JPM) bought it for $1.9 billion. I lost most of my money.
What I learned:
Don’t base a decision on only one research view. These days, I still use Morningstar research, but I get second opinions from a large national-broker dealer’s research. Corollary: Resist the urge to buy or sell compulsively. Wait a day, at least, for the mental dust to settle.
Dig deeper into why a company has gotten to where it is. I didn’t perform enough due diligence about the reasons for Washington Mutual’s success. Washington Mutual’s strong California franchise funded their expansion to other markets just as the housing market in California was teetering, and then cratering. Washington Mutual was doubling down on its strategy in the face of impending disaster. I thought they were brave, but instead they, like I, was foolhardy.
Internalise the concept of real risk. Risk is not standard deviation. Risk is the permanent loss of capital. I didn’t believe it until I experienced it.
Bargains are bargains for a reason. The market is great as a voting machine. Respect it.
Take your lumps. I held onto Washington Mutual stocks even as the warning signs piled up in the hope that the stock price would recover. The market doesn’t care about my getting back to break-even. Admit a mistake, take the loss, and move on.
Since 2008, I’ve separated my stock investments into short-term and long-term buckets. I will occasionally hold stocks for less than a year, and have owned some for several years. I am grateful that the Washington Mutual nightmare didn’t dissuade me from investing thereafter, and for the expensive lessons that I learned in the process.
The Nightmare on Wall Street
by Peter Bull, Head of Equities, Morningstar Investment Management Australia
Around December 2007, a lot of the big Wall Street firms were trading very cheaply relative to where they had been over the preceding years and even during the run up in 2000. I was living in the United States focusing on non-US stocks for work, and I listened to some very well respected and famous investors recommending these firms as being incredibly cheap. And so, I invested in my personal accounts in some of them. It wasn't more than I could afford to lose, but of course it doesn't feel that way when you only recover 50% of your investment. Watching statements come through the mail with new and strange-looking stock identifiers for companies that have gone bankrupt is an experience I'll never forget. I didn't even know how to get rid of them.
What I learned:
There were several important lessons, of course, like always do your own research and don't listen to pundits or stock stories. The best stock story is a list of everything that can go wrong that turns out to be quite boring.
The most important consideration I think is that when you look at companies to invest in, your mental checklist should include thinking about the business completely independent of its price. People get overly excited by price action because it's so accessible and easy to correlate with interesting stories in the news or exciting developments in the future. But looking at price in this way can be a terrible mental short-cut to take. Some businesses are robust to 90% of the bad things that can happen, while others are a complete coin-toss if they will even survive the next bad thing, whatever it is. It requires real thinking to get through it because it's not obvious in many cases. Appropriate position sizing is also key to surviving your mistakes - and there will be mistakes.
A good and practical thought process is to really think of what your required return is for a given investment instead of jumping straight to what its recent price history is or what its short-term expected return is according to some model. Different investors can have different answers to the same questions about risk preferences and required returns and still be correct. They definitely don't need to let the market dictate what's fair compensation for risk. Ultimately, investors who want to build wealth slowly with stocks, or those who have more modest expectations of them, are in the end more likely to be successful with them. Consider the alternative - we all know how "get rich quick" turns out.
This article originally appeared on Morningstar Canada
