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2011 Stock Market History: MF Global Bankruptcy

Some things don’t seem important until they are gone. Concerning the importance of liquidity, the public learned this the hard way with the MF Global bankruptcy.

mf global bankruptcy

MF Global was a global derivatives broker providing many various financial instruments. The key word in there was global. Because the company’s reach spread through international waters, the way this debacle played out became increasingly complex.

After a series of poor decisions, a riskily placed bet of over $6 billion on bad European debt put the nail in the coffin. Scrambling to keep these bets viable, the company unforgivingly transferred customers funds into their account. It only took a few days before the final bell tolled.

Due to recent events, the company had a bad reputation for poor decisions across its ranks already. A commodity trader at the firm tried to take advantage of a temporary shutdown in MF Global’s risk management system. Trying to turn a personal profit, he ended up losing the firm $141 million in ill-placed trades.

The fact that such a mistake took place reflects on the competency of the management there, who really take the lead behind the CEO. Turns out, the U.S. Commodity Futures Trading Commission recognized this and fined MF Global several times for risk supervision failure. [click to continue…]

2010 Stock Market History: Blockbuster Bankruptcy

Steve Jobs once said, “cannibalize your product or your competitors will do it for you.” In the case of videos, Netflix and Redbox were the new competition. This and more contributed to the blockbuster bankruptcy of Blockbuster Video.

blockbuster bankruptcy

Before the Blockbuster bankruptcy that was preceded by Hollywood Video’s bankruptcy, Blockbuster’s origin story sounded like every other good business success. Before the internet and Netflix, Blockbuster had carved out a very profitable business model.

DVDs, and VHS tapes before that, were bought just once. The inventory was then rented out and turned a profit on itself after just a few rentals. The same inventory then brought repeat business for as long as demand would allow. For some popular movies, this “free” profitability could last for years.

The products also saved the customer money. For the fraction of the cost of box office tickets or outright purchases, customers could view the titles they always wanted to see.

For decades, Blockbuster was the king of its industry. As the number of Netflix subscribers 10x-ed from 1 million in 2002 to 10 million, Blockbuster slowly started to die as it saw less and less traffic in its retail locations. The famed billionaire Carl Icahn did his best to try and revive the company, but it was too late. On September 23, 2010, Blockbuster filed bankruptcy.

For the young and trendy people, this bankruptcy came as no surprise. Their consumer habits had already shifted towards the more convenient Netflix. But for the “out of touch” investor, the bankruptcy should still have come as no surprise as well.

Like is the case with each of the bankruptcies we have studied, the writing is on the wall before a company files. Filing for bankruptcy is the last desperate surrender. So as investors, we can avoid getting axed by paying attention and knowing what to look for.

So what warning signs did Blockbuster show investors? Like always, I need to see hard proof. It’s easy to say that Netflix was going to take over Blockbuster, because we have perfect hindsight and the luxury of seeing these events already play out. [click to continue…]

5 Tips of Investment Advice for Teenagers

Got a request for investment advice from a high school senior who reads my blog. Here’s what he asked.

“I know I’m very new to this, and your 7 steps for beginners gives me the confidence to take the initiative to invest. What kind of advice would you have for a high school senior? It’s hard to find information about people investing while in school and if you have any advice to share I would greatly appreciate it.” –Frank

If I could go back in time, what would I say to my teenage self?

investing advice for teenagers

1. Avoid debt at all costs
If you want to become wealthy, debt is the biggest obstacle in your path. This one hits me hard, because I bought the idea that student loans are normal. Hook, line, and sinker.

Don’t get me wrong, a college education is crucial towards your development and success. But a student loan is not the keys to a trust fund. And I spent money like it was.

There were plenty of times when I had student loan money left over. Instead of using the money wisely, I wasted on who knows what. Lots of my friends did the same thing too. Also, I didn’t utilize used textbooks websites til late in my college career. Hundreds of dollars down the drain. Don’t forget the thousands of dollars I spent in tuition because I graduated in 5 years instead of 4. Or the time that I chose the much more pricey on-campus apartments because they were cool.

Look, I made mistakes when I was young. We all do. But I wouldn’t trade my experiences for the world. A lot of what I’ve done has made me into the person I am today.

That being said, if I were to do it all over again… I’d graduate with a lot less student loan debt. And I would’ve started investing a lot earlier than I did. These are the little things that can make a big difference over the long run.

2. Build a savings habit
This is one of the hardest things for grown “adults” to do. Trust me, that little voice in your head that wants to be a spoiled brat NEVER goes away.

You don’t have to become Ebenezer Scrooge, but even just a little bit of savings can go a long way.

If you are a teenager, you don’t have many bills anyways. $10 a paycheck (if you’re working part time) can turn into $500 a year. If you earn 11% on that $500 in the stock market over 47 years (from age 18 to 65), you’d have $67,000. That can buy you a pretty nice Audi. Or if you’re really greedy, you can invest that $67,000 in a dividend paying stock and earn $3,000 a year in dividends.

All that is just on one year’s savings. Imagine if you made it into a habit, and did it every year. Add $10 a week, every week for 47 years, and you’d have $716,292! The power of compounding interest and good stock market returns is truly incredible.

You don’t have to be wealthy, especially if you are young. There is power in starting now. [click to continue…]

2009 Stock Market History: Nortel Bankruptcy

If there ever was a company who fully represented the stock market during the early 2000’s, Nortel would be it. From being one of the biggest benefactors to the dot com boom, to one of the biggest crashers, to accounting scandals, to failed restructuring and bankruptcy… the Nortel bankruptcy encompassed all of this and more.

nortel bankruptcy

The Dot Com Bubble

So how did this all start? The wild ride known as the Nortel bankruptcy was thrust into the public eye during the late 90’s. Internet stocks were all the rage, as were any companies that serviced these stocks or were seen to be a part of the new technological revolution. Network and telecommunication stocks like Nortel were among the most popular during this time.

Investors expected computer networking to take over the world of business like never before. The technology itself was seeing exponential growth in efficiency which led to the same kind of growth in profits, or at least it should’ve. The general public thought this trend would never end.

The stock market reacted to all of this optimism accordingly. With expectations through the roof, stock prices followed. Companies during this time period didn’t even need to be turning a profit, as investors excused traditional valuation metrics as old and obsolete.

People saw the new technology as being part of a new world. They thought that they had entered a new era of investing, one where all of the old rules didn’t apply.

Economic theories such as the “greater fool theory” began to be more accepted and utilized, though it didn’t have a name at the time. The idea behind the greater fool theory is that it doesn’t matter at which price you buy a stock, because as long as the stock price keeps going up, there will always be a greater fool who is willing to buy it from you.

This strategy worked for investors during much of the late 1990’s. It created one of the biggest stock market booms that we had ever seen, and pushed stocks like Nortel up to towering highs. Nortel’s market capitalization got so high at one point that it was bigger than one third of the entire Toronto Stock Exchange index.

Nortel wasn’t even making money during this time, people just expected that profits had to materialize in the new technological world.

As you can imagine, it didn’t end like these investors expected. Once the dot com bubble popped, stocks that were driven up by the optimism got equally pummeled on the way down. Some, even most, didn’t survive through the crash. Negative earnings and other factors got the best of these stocks and bankrupted them.

The Aftermath

However, Nortel survived. The stock price took an absolute beating, but the company was able to hang around until 2009. In the meantime, it was able to pick up the pieces from the dot com debacle and even rebound into profitability through major restructuring with new management.

Frank Dunn, the CEO at the time, was credited for turning around the company and launching them from their dark years in the red into positive net earnings in 2003. Dunn and his management team were promptly rewarded with hefty bonuses.

The victory was short lived, as it was discovered that the company had been fudging their books and misallocating figures. Investigators finally found errors in excess of $3 billion just relating to revenue alone. The lofty executive bonuses had to be paid back, though only 10% or so could be recouped.

Nortel picked up new management, survived the accounting scandal, and continued to plod on through years of mediocrity until the housing crisis recession put the nail on their coffin.

It’s kind of a sad story. To see such a fall from greatness, followed by a slow and painful death. Even another restructuring in 2008 couldn’t save Nortel.

What was the problem? Was data networking just not that profitable? Or did management just continue to fail, no matter who was put in position?

Today’s High Flying Stocks

We have to look into the numbers to really find the answer. I think it was some combination of both, but I am just speculating. What we can learn from this is that there will be stocks who follow this same pattern again. Which stocks these will be nobody knows, but even as I write this there are several companies with low profitability and record high stock prices.

A company like Tesla continued to book annual earnings losses yet the stock kept rising higher and higher.

Companies like Netflix and Amazon continue to follow a straight line pattern upwards yet struggle with low profitability in relation to their share price.

These companies are undoubtedly leaders and innovators in their respective technological fields. Yet like Nortel learned, a claim to greatness means nothing if you don’t have the financials to back it up. No matter how high your stock price gets.

The Nortel bankruptcy story finally concluded with its filing on January 14, 2009. The once great telecommunications and data networking company, a leader since 1895, was dead. [click to continue…]

2008 Stock Market History: Washington Mutual Bankruptcy

When people think of the Great Depression or financial hardships, the picture of lines of people scampering to get their money out of the bank comes to mind. When panic like this strikes, it looks like a scene straight out of a movie. During the Washington Mutual bankruptcy however, this was the reality.

washington mutual bankruptcy

If one thing was certain, it was that the CEO of Washington Mutual was ambitious and had good intentions. While this attitude can be helpful, it doesn’t save someone from ignorance. The world is a harsh place, and you have to learn how it works.

The goal for Washington Mutual was to make them into the Walmart of banking. This meant catering to lower class individuals, and dealing with their inherent increased credit riskiness. For this bank, that meant marketing sketchy products like adjustable rate loans. They even pressured sales reps into overlooking asset or income limitations for borrowers.

Washington Mutual was a company that was angling to be “for the people”. Also known as WaMu, the company tried to be the “cool” bank in the midst of the uptight and traditional banks.

Turns out, they also ran their financials in the same way. The company appeared to defy the traditional rules of leverage and liabilities, until a $16 billion bank run on deposits left them to the whims of the FDIC and hurled shareholders into a nasty bankruptcy.

It’s easy to point the finger at the 9 day, $16 billion bank run for causing WaMu to go bankrupt. But this was a company with over $300 billion in assets. Something else had to have happened.

What gets lost in translation was that the 9 day bank run was prompted by a credit rating downgrade for Washington Mutual. A look into the financial statements helps us determine if their credit downgrade was really justified.

So let’s look at that last annual report before the Washington Mutual bankruptcy. This was filed on February 29, 2008, a full 6 months before the September 26, 2008 bankruptcy (remember that parenthesis indicates a loss, or negative number).

washington mutual value trap indicator

The first thing that really jumps out to me is the high dividend yield. This can both be a sign of a great value play or a sign of a dangerous value trap. [click to continue…]

2008 Stock Market History: Tribune Bankruptcy

The rise of the internet contributed to the downfall of traditional media, especially newspapers. Companies that had been running for over a hundred years were now in danger of losing their shirts. The Tribune bankruptcy was one such instance.

tribune bankruptcy

The way that the Tribune bankruptcy played out is quite a special one. While the business was definitely negatively affected by the internet and “new media”, they were in no means treading on dangerous territory.

That is, until an investor named Sam Zell took the company private on December 20, 2007 with a buyout of $34 a share. Zell thought he could save the company with this bold move, a leveraged buyout that instead crippled the company and put them in bankruptcy a year later.

With burgeoning debts and a crippled business model, Tribune filed for a Chapter 11 bankruptcy on December 8, 2008.

A chapter 11 bankruptcy is slightly different than the chapter 7 bankruptcy that we commonly hear about. The main difference is in how the debts are treated.

Ch. 7 vs. Ch. 11

A Chapter 7 bankruptcy is the more traditional variety when we think of bankruptcy. In it, all of a person’s or company’s assets are sold off and used to pay the debts. The advantage of the Chapter 7 is that oftentimes, some of the debts are forgiven and it becomes a pretty clean break.

The Chapter 11 bankruptcy is different. In this scenario, assets are not sold off and instead the debts are renegotiated. The debtor is given a chance to revise the terms of the loan to make payment. You can easily remember the difference between a chapter 7 and chapter 11 by the following terminology: Ch.7 is a liquidation, and a Ch.11 is a reorganization.

In the bankruptcies we’ve investigated so far, they’ve all been Chapter 11 bankruptcies. This is the most common bankruptcy when you are talking about corporations. Now what made this Ch. 11 bankruptcy so interesting was that it took four years to resolve. Quite a long time.

In the end, the Tribune bankruptcy was an example of a private buyout gone wrong. The good news for shareholders was that they got paid and got out, while Sam Zell took the brunt of the damage from the bankruptcy. To be fair, he was a big reason why it happened in the first place.

What Killed Tribune?

The story that this event paints is actually different from what really happened. What killed Tribune was not the dissolution of the newspaper, while it did have a minor effect. What really put the company down was the insane increase of leverage from 2007 to 2008, and this is what prompted the bankruptcy.

If there was no leveraged buyout, we may very well have never seen a Tribune bankruptcy in the first place. While we’ll never know for sure, we can look at the numbers to confirm this idea.  [click to continue…]

2008 Stock Market History: Circuit City Bankruptcy

When a high profile company collapses, people tend to take notice. Especially when it is a well-known retailer like Circuit City was. There were many contributing factors to the Circuit City bankruptcy, but it’s easy to say it was obvious with hindsight. Or was it?

circuit city bankruptcy

Circuit City enjoyed a chief prosperity during the 80’s and 90’s. Business was booming and naturally, it was expanding. People were buying up everything in the stores, from electronics to appliances… it was starting to be known as the store to buy from before you head off to college.

But the good times didn’t last forever, and eventually it slowed down. The retail empire took a backseat to Best Buy. They stopped selling their profitable appliances. Growth diminished, before it became hard to get customers in the store at all.

The Circuit City Bankruptcy

By the time that the housing crisis meltdown hit and the economy entered into a full blown recession, Circuit City was on life support and couldn’t take it any more. On November 10, 2008, Circuit City filed for bankruptcy.

How could this have happened to such a great store? Of course there’s plenty of speculation, but former CEO Alan Wurtzel thinks that it’s because management didn’t adapt.

He blames executive pride, as well as the inability for radical change due to shareholder backlash, as contributing to the eventual demise. In an store selling technology, is it really a surprise that you need to be on your feet and can’t rely on the past?

These are questions that aren’t as obvious as they seem to be. Surely for Circuit City, these are questions that weren’t pondered enough and you see the consequences of that. But is it really that easy? Sure you can look back as you sit in your chair and say that this one factor was the final straw, but I don’t think it was ever that simple.

Risky Sector

Most people don’t realize that one of the riskiest sectors in the stock market is retail. I’ve written about this before, how the retail industry had the most major bankruptcies out of anyone since 1994.

Although retail is very well known and certain brands easily become household names, it is very hard to stay in business in that industry. There’s so many factors that I can’t give you just one reason, but it’s hard to argue with the facts.

So knowing this fact and then reexamining this story, it shouldn’t be that shocking that a company as well known as Circuit City went under. If you look at the numbers, it’s even less. [click to continue…]

2008 Stock Market History: Lehman Brothers Bankruptcy

Too big to fail. These were the words that echoed into history books and characterized the shocking aftermath behind the Lehman Brothers bankruptcy.

lehman brothers bankruptcy

The premise behind “too big to fail” was simple. There are certain companies on Wall Street that are so massive, so hopelessly intertwined with the everyday economy, that their collapse would mean the destruction of modern lifestyle as we know it.

Lehman Brothers was thought of as one of these kind of companies, with a peak market capitalization of $60 Billion before it went under. In the end though, big banks like Bank of America, Citibank, and AIG got bailouts while Lehman Brothers and their shareholders were left in the cold.

But how did it all start? How did they get to this point of no return?

Subprime Mortgage Crisis

Lehman Brothers was the perfect example of how to ride an investing bubble all the way up and then all the way down. You see, the company had built a substantial portfolio around mortgage backed securities. Not only that, but they were leveraging up to do it. As the housing bubble continued to cruise, Lehman’s profits exploded and catapulted the company from around $20 to over $125 per share.

While everybody remembers about the housing crisis, not many remember that the correction happened in 2005, and it was the resulting subprime mortgage crisis in 2007-2008 that really did in our economy. This subprime mortgage crisis crippled Lehman Brothers’ profitability and forced the closure of their subprime lender BNC Mortgage, before completely finishing them off.

This scandal was unique not only because of the sheer size of the bankruptcy, but because it’s pretty obvious that the major cause was the leveraging.

Sure there were cases of malfeasance where quarterly reports were smudged to look better, and grumblings about the increase of pay and bonuses for top executives during and leading up to the bankruptcy crisis… but the real reason for the Lehman Brothers bankruptcy was plain and simple, debt.

Now it’s easy to say that they had too much debt in hindsight, but I want to prove to you that it should’ve been obvious even to unsuspecting investors. The sheer number of shareholders who were taken aback by this bankruptcy should attest to how ignorant investors really are.

Let’s look at the last annual report filed before bankruptcy, in January of ‘08. Keep in mind that Lehman Brothers filed bankruptcy on September 15, 2008.

LEHMQ Value Trap Indicator

There was a 2 for 1 stock split in 2005, which means that the company had a very stable track record of growing revenue, earnings, EPS, and dividend. Even their net cash was increasing at a long term trend, but all of this growth came at a price.

When a company is growing at this kind of a torrid pace, you have to look at their debt levels and see if they are sustainable. [click to continue…]

2002 Stock Market History: Worldcom Bankruptcy

The years following the dot com boom were clouded with accounting scandals and bankruptcies. Shortly after the infamous Enron bankruptcy, in which a leading energy company was exposed for cooking the books, the world was rocked again by the biggest bankruptcy seen to that point, the Worldcom bankruptcy.

worldcom bankruptcy

Worldcom was the nation’s second largest long distance carrier, behind AT&T. Like the Enron case, the former CEO quit just months before the bankruptcy disaster, yet his involvement in the fraud proved to follow him anyway with a 25 year federal sentence.

A failed acquisition attempt of phone company competitor Sprint preceded this groundbreaking event. Regulators had determined that this deal would violate monopoly laws, and blocked the transaction. Just three years later, the Worldcom bankruptcy became the biggest bankruptcy in U.S. history with $104 billion in prefiled assets.

For this company, the writing was on the wall and former CEO Bernard Ebbers knew it. Unbeknownst to the general public, Worldcom was clearly struggling in a declining telecommunications industry and shrinking profits.

The Sprint deal was a last ditch effort to save the health of a declining stock price, but when the deal fell through Ebbers faced a dilemma. He was trading options on company stock to fund other businesses, and because the price was declining, he was being forced into covering margin calls.

With the danger of his selling company stock leading to even worse stock declines, Ebbers convinced the board to loan him hundreds of millions of dollars to cover the margin calls. Not only did this lead to the infamous black stain on Worldcom, but it also didn’t work, as the stock continued to free fall all the way into bankruptcy.

Worldcom Fraud

The fraudulent behavior didn’t stop there. As Worldcom faced bigger and bigger losses, top executives formulated some tricky accounting engineering to fix their problems.

These executives propped up revenue numbers by creating a completely fabricated entry called “corporate unallocated revenue accounts”. It didn’t stop there. Instead of accurately recording “line costs” as expenses, Worldcom placed these in capital expenditures.

These two devious mistakes over inflated assets by over $10 billion and completely betrayed the investors brave enough to still support the company. Unfortunately, the bankruptcy news completely blindsided those investors.

To make matters more confusing, take a look at this. In 2001, Worldcom split its stock into two different groups. The ticker that used to be $WCOM split off into Worldcom Group stock ($WCOM) and MCI group stock ($MCIT). The MCI group stock, also known as a tracking stock, was an attempt to make Worldcom look better by separating its losses from the income statement.

While this temporary fix may have pacified troubled investors, with the tracking stock even paying a dividend to lure in more victims, the tracking stock was eventually closed down and converted back into $WCOM shares.

This recapitalization move again made things tricky for investors at that time. Because now, in the 2002 annual report, they were able to separate earnings into the $MCIT loser and $WCOM.

Here’s what the earnings looked like without the $MCIT dragging them down.

worldcom annual report

And with the corresponding Value Trap Indicator values (remember < 250: Strong Buy; > 800: Strong Sell): [click to continue…]

2001 Stock Market History: Enron Bankruptcy

The Enron bankruptcy was among the most surprising and shocking events that the investing world has ever seen. Never before had a company once been held in such high regard, respected and even honored among the top companies in the Fortune 500 and across the world. This tragedy forever shook the confidence of the individual investor about Wall Street and the general integrity of mankind.

If you weren’t paying attention back then, you might not now realize the magnitude of what really happened. Not only was Enron a highly diversified company, dipping its toes in natural gas, electricity, paper and pulp, and communications, but it was also an undisputed leader in the energy space. For investors at the time, everything seemed smooth. They paid a dividend at around 0.5% – 1%, they boasted steady and growing earnings, and even had a mostly average P/E ratio in the beginning of 1999, at around 30. Everything seemed to be going according to plan.

Just how well respected was Enron? Well, Fortune magazine had heralded the company as “America’s Most Innovative Company” for six years in a row. Behind the scenes, top executives were cooking the books and hiding company losses to avoid suspicion. But even though the Enron bankruptcy is widely known as the accounting scandal that caught everyone off guard, I’d like to argue that a prudent investor would never have bought stock in the company in the first place.

enron bankruptcy

The way that Enron cooked the books was through a method called “mark-to-mark” accounting. What this would entail, according to “The Fall of a Wall Street Darling” by Investopedia, was the immediate credit of an expected asset’s profits. For example, the company would build an asset, like a power plant, and then would count earnings on that asset before they even materialized. After that Enron would transfer the asset to an off-the-books corporation, so that when the actual loss was accounted for, it wouldn’t affect Enron’s bottom line.

Now of course this is highly deceitful and unpredictable. There was no way for the average investor to be able to research and find out this was going on. But there were some other warning signs going on in the financial statements, ones that you’d only find out if you look past the superficial earnings and income numbers.

Take a look at their last annual report before bankruptcy, the one filed in 2001 (I took the liberty of filling out a spreadsheet for you with just the important numbers).

bankruptcies

Again, on the surface everything checks out. You see growing revenue. Growing earnings, EPS, even a stock split. You see everything trending in the right direction… up. Total assets, shareholder equity, and of course share price.

But let’s look further. The reason why a tool like the Value Trap Indicator works so well is that it takes seemingly meaningless data and transforms it into something useful. We are able to understand if a particular ratio is extremely high or low because the Value Trap Indicator computes this automatically. Because the Value Trap Indicator is centered on a ratio’s desired average, and because many of the categories deal with the difference to the average as raised to the second power, extremes in ratios are quickly identified and flagged. You can’t hide from it, not even Enron.

So if we extend down the spreadsheet to look at other ratios, we see an interesting anomaly. Remember, most of the ratios look great. Even though the P/B, P/E, and P/C get pretty high at some points, they don’t get high enough to really cause us to worry. The red flags pop up, as they usually do, with the debt to equity ratio. Look at its progression below. [click to continue…]