The Big Picture for the Week of June 24, 2012

As a followup to posts from earlier in the week about over confidence a reader asked for my take on how to avoid holding onto a stock, like Eastman Kodak, too long. There is no single answer of course or simple recipe for avoiding all of these. The best way to try to answer this is with various but different types of examples. Each incident like this will have unique aspects but there are things to learn from past Kodak-like stories to apply to future incidents.

One type of example is a seemingly obvious management goof. In the past I mentioned owning the old AOL stock personally when they announced their takeover of Time Warner. I was in a different part of the business back then and I was not blogging but it seemed like an obvious and ill-fated decision and I sold it right away. Although different at the detail level this seemed similar to Bank of America's (BAC) decision to take over Merrill Lynch which again seemed obviously ill-fated. Learning from the AOL news helped avoid most of the implosion at BAC as we sold it immediately after the Merrill news. Keeping on top of this requires having some understanding of a management's strengths and weaknesses and having an eye for the stupid.

Obsolescence is another thing to look out for. This is what Kodak was about. A reader left a comment about the old Digital Equipment in the same context. What about Polaroid? The stock market was pricing Apple (AAPL) like it was obsolete during the mid-1990s but the company figured a way to reinvent itself. Some companies do reinvent themselves which can make this more difficult but this happens. Sony (SNE) is trading like it is mostly obsolete. In Sony's case it seems like consumers no longer want to pay a premium for the brand. The TVs in our house are all very cheap, I've never considered buying a Sony. If we only get five years out of a $300 TV (we've done better than that) so what, it was $300. Keeping on top of this requires paying some amount of attention to trends in technology.

One example also mentioned here in the past is Bernie Ebbers having a $100 million margin loan against his Worldcom stock. There was a stretch were David Faber talked about this repeatedly and I would say he potentially helped a lot of people--those who were listening. Someone like this having outstanding margin loans was and still would be ludicrous. There is something that is kind of similar today with Aubrey McClendon and Chesapeake (CHK). I don't know the particulars here or whether McClendon still has margin loans but I don't own the stock so I don't need to spend time finding out but this is a warning even if CHK does not come anywhere close to meeting the same fate.

In the last 12 years there have been two huge mania (tech and then all things related to housing including bank stocks) and quite a few smaller ones (solar and Chinese solar come to mind). There will be other manias in the future. Recognizing these manias doesn't seem as difficult as recognizing obsolescence as much excitement is generated along with plenty of this time is different type of talk. Having exposure to a mania isn't the worst thing that can happen so much as having too much exposure to a mania. At one point a little over a year after First Solar's (FSLR) IPO the stock was up 1000%. If you are ever lucky enough to be on the right side of one of those don't be afraid to sell some every 100 or 200%. Someone selling some along they way would have made a lot of money on FSLR even if they held on to some shares all the way down in the stock's 95% decline since its peak.

One last type of example circles back to the financial crisis. I've joked a few times about how many times do you have to read that the housing market in Europe stinks before you sell the European banks? We sold Barclays (BCS) in December of 2007 and Allied Irish in March 2008. Neither was a top tick but both avoided catastrophe for the simple task of reading about them regularly. Note that these sales were months after early warning shot of Northern Rock's failure so there was plenty of time to process what was happening, not panic sell and still get out relatively early.

If there is a recipe here is seems to be a combination of different things including being lucky. An obsolete product wouldn't really be much help with the financial crisis so really this is a layer of investment process that we all need to figure out for ourselves. This can be done by taking little bits of process from others.