6
Month Market Review
What
Goes Up...
Be Sure to Buy
Quality
by Randy Befumo
(TMF [email protected])
More than a few investors will end the first half of 1997 nursing broken
portfolios in spite of the spectacular rise stocks have staged over the past
six months. Many of these investors will have one of two names that are
responsible for the vast majority of their investment pain, companies worth
billions of dollars one day and bankrupt the next. Once speculative penny
stocks, these companies posted stupendous returns based on false claims,
earning them rapid price appreciation and the support of many duped investors
and professional money managers before they blew up. Reminding us that it
always pays to be at least a little skeptical despite of strict rules on
corporate disclosure enforced by the Securities Exchange Commission (SEC),
CENTENNIAL TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CTN)") else Response.Write("(NYSE: CTN)") end if %> and BRE-X MINERALS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BXMNF)") else Response.Write("(Nasdaq: BXMNF)") end if %> stand as reminders of what can go wrong when investing.
CENTENNIAL'S STORY. The best performing stock on the New York Stock
Exchange in 1996, Centennial started the year off with a bang. The company
hit its 52-week high of $58 1/4 right around the first trading day of the
year, valuing the entire company at $519 million. A virtual unknown prior
to 1996, the company had come out of nowhere in the PCM-CIA card market,
small cards with software built-in that are used most often in laptop computers.
In order to maintain its strong sequential revenue growth, the company used
stock to acquire contract manufacturers in the U.S. and England in late 1996.
Contract manufacturers slap together electronic components, a business that
Centennial believed it could handle due to similarities with the PCM-CIA
card business.
HOW COULD AN INVESTOR HAVE AVOIDED THIS LOSS? Although initially the
company's incredible sequential growth in sales and earnings attracted a
devoted following, the shares kept increasing in spite of information that
could have been viewed as neutral, or even negative. Rising in spite of potential
negatives is normally an excellent warning sign that there is more to a situation
than meets the eye. In this case, as was later revealed, it was Centennial
Chief Executive Emanuel Pinez who was manipulating the stock. Stocks that
lose track of the underlying business should be watched very closely, as
there is nothing to support them when the fickle opinions of short-term oriented
investors suddenly shift.
Even though the financial statements were falsified, an investor might have
been skeptical even if they were using them. The company had booked $19.5
million in revenues in its September quarter, giving the company $78 million
in annualized revenues. This valued the maker of PCM-CIA cards at 6.7 times
sales in spite of the fact that the company was getting into contract
manufacturing, a business with lower profit margins. That the company was
generating 12.3% profit margins when its main competitors were doing at best
half of that indicated that margins would be falling soon. Investors who
waited for the company to actually report a quarter with lower margins would
have bailed out on
January
30th.
When the company shocked investors on
February
11th with news that it was firing its Chief Executive and restating prior
quarters, investors were stuck. Centennial did not trade again for more than
two weeks, when it opened substantially lower. In spite of the facts that
Centennial had lied to investors, the New York Stock Exchange was pursuing
delisting procedures, and the Nasdaq and American Stock Exchange had both
said they would not allow the company to be listed on their exchanges,
investors
still bought the stock as the day progressed, driving the shares up to
the low 'teens before good sense prevailed.
The most powerful lesson to draw from this is that naive investors for some
reason want to believe, often in spite of mounting evidence that indicates
that what they thought was true was actually a lie. Centennial was delisted
only days later, leaving those who bought it on February 25th with nothing
but regrets, the last and perhaps most gullible victims of the scam.
BRE-X's STORY. As if the trading in Centennial after the company was
set to be delisted was not bad enough, the cottage industry of conspiracy
theories that sprang up to justify continuing to hold Bre-X Minerals stock
was even more stupefying. Bre-X Minerals was a tiny Canadian natural resources
company that rose to prominence in 1996 after the company claimed to have
found the largest gold deposit ever. A Canadian gold stock valued in the
pennies, the company was everything that reasonable investors avoid when
they evaluate a stock. The widespread delusion that the only way to create
wealth on the stock market is to buy low-priced, speculative enterprises
is one of the most avoidable sources of capital loss for individual investors.
FREEPORT-MCMORAN COPPER & GOLD'S <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FCX)") else Response.Write("(NYSE: FCX)") end if %> decision to help
Bre-X develop the claim lended credibility to the company. Even when Freeport
decided against investing cash in the company on
February
18th, many investors still treated Bre-X as a premier natural resources
company. Although the only difference between Bre-X in the pennies and Bre-X
valued in the billions was one gold claim it needed help to mine, many investors
were more willing to buy its shares than those of some of the oldest, largest,
most well-established mining companies in the world with more compelling
valuations relative to their gold claims. Bre-X was so strapped, in fact,
it was willing to give up 15% of its claim to Freeport just for Freeport
to assist with the mining.
HOW COULD INVESTORS HAVE AVOIDED THIS LOSS? When Bre-X's chief geologist
apparently committed suicide by jumping out of a helicopter on
March
21st, the company's explanation that this was due to the geologist learning
he had hepatitis B stretched credibility. When Freeport found on
March
26th that "to date, analyses of these cores [from the Busang deposit],
which remain incomplete, indicate insignificant amounts of gold," it was
almost too late. The shares dropped to around $3, where they held up because
of dedicated efforts by investors to explain the events in a way that made
the investment in Bre-X appear to be a good one. Investors almost immediately
began concocting conspiracy theories that had the Indonesian government and
Freeport trying to steal the gold.
Instead of rationally assessing the risk that there was no gold and preserving
some capital, investors in Bre-X after it reopened in early April appeared
to be more interested in passing convoluted theories that left Bre-X an angel.
Bre-X finally collapsed on
May 7th
when it was revealed that the original core samples had been falsified --
perhaps better explaining the chief geologist's suicide.
Even if the conspiracy theories had proven correct, it was hard to imagine
how such a well-orchestrated plot to defraud Bre-X and its investors would
have eventually worked out in the investors' favor and justified their continuing
to hold the stock. Bre-X investors would have been much better served using
the energy they put into justifying their investment into finding a new one,
admitting their chances with Bre-X were grim, and recognizing the loss and
moving on. |