Sprint Nextel (S) made news yesterday because of allegations of tax fraud. Who knows where that will go but if you look at a long term chart you will see that in 1999 the stock was $70. Yesterday the stock closed at $2.40. Sprint was once a very widely held stock that did phenomenally well going up 2400% from its IPO to its peak in late 1999 (according to Yahoo Finance).
We have seen this type of demise before with the "safest" of names like Fannie Mae and stocks that probably never should have gone public like Pets.com. I think most people remember how revered Fannie and Freddie once were. Another one from the revered category was Cendant which may not be as familiar. There was a stretch in the mid 90s where Cendant was very popular as a staple holding for a lot of investment advisors (talking long before it blew up).
Fannie and Freddie were reasonably placed on the same pedestal as Coca Cola (KO) and client holding Johnson & Johnson (JNJ). Sprint too and many others that one way or another failed (either literally or effectively) were very highly regarded. How about the entire US auto industry? The carnage there has been epic.
If we did some sort of poll and built a portfolio of the 20 safest names to hold for the next ten years, like so many magazines are fond of doing, it would be a very good bet that at least a couple of them would disappear.
This is not to say that predicting a failure at Pepsi or Honeywell would be anything but a lucky guess but that is the point. Any stock can go to zero. Apple could disappear. Again, not a prediction as there is no visibility for any of these to fail but it happens and often there is no warning--at some point starting in 2003 there may have been visibility at Fannie and Freddie as Freddie got into some trouble over accounting issues.
If you can accept that anything can fail then the issue of position sizing becomes critical. This has been covered here many times in terms of targeting individual stocks at 2-3% of the portfolio as many others go with larger weightings for their holdings. Getting caught in something that fails is not the worst thing that can happen to an investor because it can happen to any company. It is bad to get caught with 10% of the portfolio in something that fails and this happens. Based on experience working at brokerage firms, anytime there is a spectacular one day implosion in some stock there are invariably investors with only that stock in their portfolios and they own it on margin.
An extreme example but it makes the point.
Proud Member Of
Random Roger
© 2009 | Gadget Theme Blogger Template
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
9 comments:
In my investing I try to keep a single position below 5%, but more importantly I have (informal) maximum weightings on sectors, countries, and brokerages. This last part seemed stupid until MF Global came along.
I worked at Lucent in the late 90's, and many coworkers there had significant percentages of LU in their 401k's. That was a great investment until 2000, resulting in 7-figure retirement accounts becoming 5-figure retirements combined with layoffs in just a year. Only two people I knew sold in time.
Rich
Lucent, great example
I worked at Eastman Kodak starting in 1971 when Kodak was at the pinnacle of its dominance. Shortly after joining the company a Merrill Lynch broker convinced me to purchase Kodak ON MARGIN at $150 per share. Everyone I knew in Rochester owned as much Kodak as possible since it was an American institution.
Kodak never saw $150 again and now it is gone. People in Rochester are still stunned even today...
Why did I never hear about the Fannie Mae debockle. With companies being public and in such a limelight of their success, who thinks its ok to possibly fudge accounting? Logic is lost somewhere.
EK, again, great example.
This column brings mega-blue chip GE to mind. It was around $40/share pre-2008/09 crash, got to as low as around $5/share; and currently trades in the $19-$20 range. Wish I had loaded up at $5, but you never know when that knife is going to hit bottom.
Interesting, I hadn't even noticed Sprint. They were supposed to get SO profitable when they bought Nextel, 'cause Nextel had the highest margins and best customer loyalty in the industry.
Add Wachovia and AIG to the mix. The CEO's stated publically that all was well...and then poof (although AIG is still in business). They lied to everyone. What type of system is this. Is this what free-enterprise and capitalism really means?
Position sizing is critical to portfolio risk management. I agree with your 5% individual stock limit. I use a 15% limit for any one ETF and 25% for any industry, although I would seldom approach the 15 or 25% limits.
I have written an article titled " The Art of Position Sizing to Manage Money and Risk" for anyone interested at:
http://blog.arborinvestmentplanner.com/2011/12/the-art-of-position-sizing-to-manage-money-and-risk
Post a Comment