Investor Summer School: Five Lessons that will Help Protect Your Portfolio
One of the fascinating things about the market is that, no matter how long you invest, or how much you think you know, there can always be new lessons learned. For a lot of investors, losing money — unfortunately — is often the cost of tuition for these market lessons. But, no investor is going to bat 1.000, and if you can at least learn from your mistakes then your portfolio will, most likely, be better off in the future for them. That being said, let’s look at some lessons investors should have been paying attention to over these past few hot months (both weather-wise and market-wise).
Short sellers can sometimes be VERY right
Shareholders in Valeant and Concordia International know this all too well. Aggressive short sellers targeted both companies. Some investors think that the way to avoid getting hurt by stocks like this is to avoid ANY company that is actively shorted. But we think this is a mistake. Short sellers are right sometimes, and wrong sometimes. Take a look at EBIX Inc. (EBIX on NASDAQ). It has a short position of 31% but the stock is still up 73% this year. In addition, a ‘short squeeze’ where short sellers desperately try to cover positions in a rising stock, can be a very powerful way for longs to make money. Shorts, like any trade, are just another opinion. We think the best lesson is to at least understand WHY your stock is being shorted. Information is key. Maybe the stock valuation already reflects this risks the shorts think the stock has. Maybe not.
Greed always rears its ugly head
This week, the stock of Neuromama traded on the OTC in the US (symbol NERO), hit a $35 billion market value, despite having no revenue, no financial filings for two years and key executives who have previously been sentenced to prison time for securities violations! That valuation put it higher than Tesla Inc., and other ‘real’ high-flying companies. The stock is thinly traded (before its recent halt), and the OTC market can be easily manipulated. Every broker knows this, but we think investors need to know it too: The OTC market is a gong show market run by drunk cowboys intent on stealing your money. Repeat after me.
Diversification will protect you
Suppose you had the aforementioned Concordia in your portfolio last month. Your stock is down about 50%. But, if you had 30 stocks owned in approximately equal amounts, your portfolio in total is down only about 1.6%, assuming no other changes. If you own some dividend stocks, and you should, that huge loss in one stock might only represent just six or seven months of your annual dividend income. Less diversification would have equated to more pain.
Cheap stocks can be cheap for a reason
This week, investors might have been surprised by big drops in certain stocks, such as Avigilon (AVO on TSX), which dropped 25% on Tuesday after taking price concessions to move inventory. The surprise comes from seeing very cheap stocks get even cheaper. “I thought the problems were already reflected in the price,” they lament. Investors need consistency and reliability. Some stocks just do not have it. They miss earnings estimates, quarter after quarter. They make excuses, such as the weather. The lesson: Just because a stock is cheap does not make it a good investment. In fact, historically we have always found ‘expensive’ stocks to be far superior investments than cheap stocks.
Debt can be a real killer
Poor Performance Sports Group (PSG on TSX), once a nearly $1 billion company now looking like it is heading for penny-stock status. This week it indicated it needed to delay its financial filings. This happens sometimes to companies, for many different reasons. But the problem was exasperated by the company’s large $400 million+ debt level. The delay could result in a covenant breach, putting the company at the mercy of debt holders if they decide to call the debt. Now, a (highly) fixable problem (without debt) just might take the company into bankruptcy. Once again, debt can put your portfolio at risk: very, very quickly.
Some of these lessons are easily learned. Avoiding debt-laden companies and catching yourself when being greedy seem like no-brainers. Other market lessons require a bit more apprenticeship. Keep learning, and by all means never make the biggest mistake of all investors — assuming you know everything and are right.
Peter Hodson, CFA, is CEO of 5i Research Inc., an independent research network providing conflict-free advice to individual investors (http://www.5iresearch.ca).