One More Reason Why One Should Wary of Stocks

Or, for that matter, jumping into the water with financial sharks under any circumstances. The NY Times has an article about the ongoing legal trials of David H. Brooks, the chief executive and chairman of a body-armor company. The article primarily focuses on what a loathsome piece of shit Brooks is: not only did he rip off investors and the U.S. government, but his body armor doesn’t work as advertised in hot weather. Which would be fine if we were engaged with Al-Queda…in Iceland.
But this section at the end caught my attention (italics mine):

One of the many former shareholders who have been tracking the trial is Michael Adair, an accountant in his 60s who says he lost most of his retirement savings, $525,000, when the stock plummeted.
He felt patriotic investing in a company providing life-saving equipment to the troops, Mr. Adair said, but first he had read the financial statements, had listened to the conference calls and had toured the company headquarters.
“I did due diligence and it turned out it was all a lie,” he said in a recent interview. “This is a trial of greed. I’m hoping to get some justice.”

Here we have an accountant who did just about all of the due diligence I could possibly think of, short of having your own private intelligence agency, and yet he was still conned.
Like Vegas, the house almost always wins. And Brooks was just unsophisticated and sloppy, unlike Goldman-Sachs. Wallace C. Turbeville, the former CEO of VMAC LLC, and a former Vice President of Goldman, Sachs recently wrote:

Kenneth Feinberg issued his report identifying outrageous Wall Street compensation of executives despite their role in the financial disaster and bail out. He proposed that the banks voluntarily adopt “brake provisions” that permit boards of directors to nullify bonuses in the event of a new financial crisis.
He might have more success asking the lions of the Serengeti to give the wildebeests a sporting chance of making an escape….
These young traders are simply doing what America has told them to do. They are allowed to earn obscene amounts of money using the advantageous information, technology and capital of their employers. Making money from less powerful counterparties is like shooting fish in a barrel.

Mind as you go….

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4 Responses to One More Reason Why One Should Wary of Stocks

  1. Russell says:

    You’re drawing the wrong lesson from Adair’s loss. The first thing every conservative investor should seek is diversification. Anyone who can lose “most of his retirement savings” because of one company’s failure has been imprudent. Yes, there are cautions to be said about investing in stocks. Among these is that no one in their 60s should have all their savings in equities. One’s investments need to be diversified in several ways, asset class as well as asset.

  2. Eric Lund says:

    Russell, you’re missing the point here. Most individual investors would not have gone to the trouble to read the financial statements, listen to the investor conference calls, and tour the plant of a company they plan to invest in. Big institutional investors will do those kinds of things (that’s one of the things you are supposedly buying with the expense ratio you pay on an actively managed stock mutual fund), but individual investors generally don’t have the time and resources to do that. Mr. Adair did, and there are securities laws in this country which say that he should have been able to rely on those statements. It’s not that the company’s business model was overly risky (if it were, he would have noticed it and presumably not put all of his money into it), it’s that the company was fraudulent. Any institutional investors who got into this stock would have been just as fooled as he was.

  3. Russell says:

    Yes, I understand all of that. There are any number of reasons that an attractive stock, on which due diligence has been performed, can crater. If the CEO had been been a sterling businessman, he might nonetheless turn out to have a secret mistress who caught him up with the mob and ended up in jail on issues completely unrelated to the business. Or, sterling in business and character, he might have had an untimely stroke. Or, some other officer might have conducted a cunning plan embezzling the company’s funds. Or a terrorist attack might kill the majority of company principals at their annual meeting.
    There are endless ways for a company to fail, that can’t be spotted simply by looking at its business and doing due diligence.
    And that is one of the chief arguments for diversification.
    Institutions diversify also. A pension plan that invests $50 million in one company can afford to do lots of research on it. But isn’t so stupid as to put the whole damn fund into that one company, even after doing so. Few pension funds will invest more than single-digit percentages even in their favorite companies.

  4. FrauTech says:

    I agree with Russel. It’s true this guy did his due diligence and the stock tanked. But it could have been for any reason. What if the body armor was fine, but some other company came along and figured out how to do it cheaper and one the next big contract. Then the stock tanks, and it’s nobody’s fault really, just capitalism in effect. They say you’re not supposed to have more than 10% of your portfolio invested in YOUR OWN company, where you’re usually buying shares at a discount. But I’d put the number at 1-3% for ANY company. Mutual funds are your friend. Invest over the long haul, and start making your portfolio more and more bond heavy the closer you get to retirement. This is why the financial meltdown managed to ruin so many so close to retirement. People had a ridiculous amount invested in stocks. Sometimes they do well for you, but they are risky and that means you can lose a lot of money.
    I doubt the guy who lost his savings was really an “ordinary” or “average” or especially “patriotic” guy. Instead he figured he knew more than Vanguard, Schwab, Fidelity with all their mutual funds and figured he could do better. That’s why he did so much research, he figured he’d hit a great investment and was going to make a lot of money on it. That’s not investing, that’s speculating. I don’t see anyone being so sympathetic to all the people who bought McMansions and who are underwater right now.

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