Financial Piece Of Mind

9 Foolish Notions I Had About Stocks

(and how you can avoid them)

1. Foolish Notion #1: Great products equal great stocks

I used to think if a company made a great product, it would ring up huge sales and net huge profits. What a quaint idea.  For a classic example (where experience put paid to that idea) consider Tivo. Tivo invented the DVR. Tivo’s DVR is the #1 DVR in the market. But has Tivo’s stock gone anywhere as a result of it?  Type the ticker into the search box at Yahoo Finance and see for yourself. 

 

Profits and consequently, stock price appreciation, have continuously eluded Tivo. 

Lesson to be learned:  Don’t equate a great product with a great stock buy. 

Whether the company is Tivo. 

Or Vonage (whose product I love and have enthused about in the post 4 decisions I wish I had made earlier).

Or Krispy Kreme. Even if you find their donuts irresistible, you may want to read my cautionary post How I Lost A Thousand Dollars on Donuts. Where I confess to foolishly trying to ape Warren Buffett and to one of my most painful and humiliating investing blunders. You don’t want to lose money that way.  And you don’t want to lose money by making the mistake of investing in wonderful products that do not have wonderful companies attached to them.

2. Foolish Notion #2: Conglomerates make good investments

I used to think if a company had its fingers in many pies – meaning it was a group of companies rather than a single company (usually referred to a conglomerate) – it was a superior investment to a company with just one line of business.  Bone-headed thinking! Not only are companies with widely different businesses daunting to manage (think of the Lilliputians trying to deal with Gulliver which explains Jack Black's appearance in this post), shady and shadow accounting is also a much higher risk with them. 

So if you are invested in one these conglomerate companies, I suggest you keep a close eye on them. And if they decide to break themselves up into different businesses each focused on its own area of strength, say a hallelujah!

It’s what shareholders of Fortune Brands are probably saying, now that Fortune Brands has decided to sell its Titliest golf balls business, its Moen faucets business, its Master Lock business, in fact all of its non-core businesses. Once the sales are complete, Fortune Brands (which will be renamed Beam) will be able to concentrate on just one business, its core business:  wine and spirits.

Lesson to be learned:  If you are tempted to invest in a conglomerate, whether United Technologies or GE or Fortune Brands, you should do so in the knowledge that you are being self-indulgent and that a company with a single line of business will usually fare better as an investment.  And don’t be surprised to find that sooner or later, the conglomerate itself will come to the same conclusion and move to sell or spin-off non-core businesses.

3.  Foolish Notion #3: The Daughter Ship is Not As Good as The Mother Ship

Sometimes when a company owns more than one line of business, it will decide to spin off a secondary line of business to shareholders.  The spin off might be an automatic spin off. Or it can be one in which you as a shareholder, are asked to choose whether you want to continue to hold all your shares in the holding company, or to exchange some of them for shares in the company being spun off. 

What should you do? 

My advice (and I learned this through non-buyers remorse) would be to exercise the exchange option, even if you are nervous that the daughter ship may not do as well as the mother ship. 

A classic example is when McDonalds spun off Chipotle. Had you declined the offer to exchange some of your McDonalds shares for Chipotle shares, it would have been a serious mistake. Because  Chipotle has increased 12 fold since it was spun off from McDonalds. Whereas McDonalds, while being on a tear itself, has only doubled in price.

Lesson to be learned:  If you are given the option to exchange some of your shares for shares in a company being spun off, always always exercise the option, even if you are a Nervous Nellie about it. You should exchange a small percentage of the mother ship's shares if that's all the courage you can muster.

4. Foolish Notion #4: An Investment is Happily Ever After  

My post Yoga for Investors aptly sums up my philosophy about investments. I have developed a gritty Till Death Do Us Part determination when it comes to investing. However, I've learned that plans to stick with a stock for better or for worse, for richer or poorer, in sickness and in health don't always pan out. Just as bonds sometimes get called away, I have discovered cherished stocks can also get snatched away from one's portfolio in the blink of an eye.  

How? How is when a company you are invested in gets taken private.

This is what happened to the shareholders of Neiman Marcus (Needless Markup, as my boss Judy used to wryly call it) - when it got taken private in 2005.

     And this is also what happened to the shareholders of Allied
     Domecq. 

Shareholders in Allied Domecq, the company that owned Baskin Robbins, Togos and Dunkin Donuts, were denied the privilege of baskin' in the sunshine of lifelong ownership.

Because Allied Domecq sold itself.

The Baskin Robbins (reason you might have bought Allied Domecq in the first place if you are like me) and Dunkin Donuts part of the business went to a clutch of private equity firms. 

The rest of the business (the bread and butter alcohol and spirits business) was sold to Pernod Ricard. 

And that’s how there was no Happily Ever After for Allied Domecq shareholders.

Lesson to be learned:  Don’t get too attached to the shares you buy. Private equity and other companies can snatch them away from you at a moment’s notice. Of course M&A doesn’t always result in a Where Did My Shares Go experience. Sometimes there’s the head-spinning (think Linda Blair in Exorcist head-spinning) Whip Lash experience, in which the original shares you bought are subjected to relentless M&A, so much so you get whip lash from keeping pace. For instance, you may start out by owning SBC shares, only to find out your SBC shares have become Comcast shares, only to find out your Comcast shares have become Cingular shares, only to find out your Cingular shares have been rechristened AT&T. This is the Whip Lash experience.  The Allied Domecq experience is different.  In the Allied Domecq scenario, you have to bid your shares goodbye as they vanish into some private equity portfolio or get swallowed up by a larger company in an all cash deal (as Skype was swallowed up by Microsoft recently).  Since both these scenarios happen quite frequently, my advice to you is to practice detachment from your shares from the get-go.  It will save you from heartbreak and acute SWS - Share Withdrawal Syndrome.

P.S. Thanks for reading this post. I know some of you thought I couldn’t spell when you read Financial Piece of Mind. If you delight in discovering typos, you might be a closet copywriter.   Back in the day when I was a copywriter, a big chunk of my time was spent proofing newsletters, brochures, annual reports and other literary works of capitalism for typos of this kind.

P.S. 2:  You also might be thinking I do not know how to count because I said 9 foolish notions about stocks but this post contains only 4.  I actually did have a list of 9, but decided to save the remaining 5 for the next post, on the grounds, too much of a good thing is bad (or too much of a bad thing is not good, in this case).

P.S. 3: The original culprit for my interest in stocks is Ajay Sachdev who is a guest poster on this blog.  After beating Velupillai Pottu at his own game at MAA (read his post A Short Stint in Advertising if you want to find out more), he went on to establish himself as a stockbroker. Barely understanding what I was doing, I bought my first stock through him.  Like Jacob with the angel, I have been wrestling the many-headed beast known as the stock market ever since.