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Posted 12/5/2005
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3 can't-miss investing ideas that can miss
It's easy to get sucked into supposedly slam-dunk investments. As my holiday gift to readers, here are three foolproof ideas that can fool you if you're not careful.
By Bill Fleckenstein
It's enjoyable to get caught up in the holiday spirit this time of the year. But for stock buyers, that can mean letting down their guard and courting losses. Amid the celebratory mood, I offer up three cautionary lessons on (1) the hazards of "renting" stocks; (2) being blindsided by "trust-me" stocks; and (3) the "profitless prosperity" that weighs on technology companies.
Debunking a 'slam-dunk'
I think that lots of folks are renting stocks -- i.e., buying them because they believe it's a slam-dunk the market will trade higher, at least into year-end -- whether or not they have any merit. Though that game is a recurring theme, I think that at this moment in time, it's occurring on a larger and more pervasive scale than ever.
Take the action in Dell (DELL, news, msgs), which is almost back to where it was the day before the company had that ugly pre-announcement about a month ago. I am assuming that the buyers of the stock think: "Well, here's a quality company. Down a whole bunch. They already pre-announced. They've announced their quarter and, sure, it was awful. But, gee, they can't need to say anything bad this soon, so it's gotta be safe to trade."
Rent now, pay later
I think that attitude permeates the tape. While it may work, it also may not, because sometimes a stock surprises you -- witness the fact that in the two days after Thanksgiving weekend, Google dropped more than $25. Not that Google wasn't "entitled" to a bit of a breather, but I think people had come to believe that the stock just couldn't possibly go down.
Related news and commentary on MSN Money
During the mania precipitated by Fed chief Alan Greenspan, which really took off in 1995, stock renters have won far more often than they ever did in the past, by my reckoning. For those of you at home who are tempted to rent a stock because it looks so easy, my experience is: The time you arrive at that conclusion is about the time it stops working.
Rickety rationale for Fannie Mae
Shifting from rent-me to trust-me stocks, I'd like to comment on "Stick to Your Guns Fannie" an article by David Dreman in the Nov. 28 issue of "Forbes" magazine. An incredibly successful value investor, he is also a noted financial author. His book "The Psychology and the Stock Market" helped frame my whole approach to investing. It explains why being a contrarian value investor seems to work so well:
People tend to behave as a herd because they desire the comfort of the crowd. Therefore, prices get far too high and too low, creating opportunities for those able to stand against the masses.
In any case, given someone of his stature, I was shocked to read the argument that Dreman laid out for Fanron (ne Fannie Mae (FNM, news, msgs)). I don't know if this is a comment on what analysis has devolved to in this day and age. Maybe it's just a function of a smart guy being trapped in a position -- an example of someone blinded by a "trust me" stock that's worked well in the past. It would be one thing if Dreman had a well-reasoned, carefully constructed thesis that we could debate. But I found the arguments so weak that they merit rebuttal.
Early on, Dreman posed this question about Fannie and Freddie Mac (FRE, news, msgs): "What were their sins? Nothing like those of Enron or WorldCom." To which I would respond: We don't know that yet. The investigation is nowhere near complete.
He stated categorically: "In both cases, the underlying business operations remain strong. These are profitable and growing companies." False. These companies are not growing. They are shrinking, though Freddie is profitable. As for Fannie's profitability, again, we just don't know yet.
Continuing on, he commented: "The chiefs of both companies and their lieutenants have stepped down. Note: Nobody has gone to jail because of the accounting errors." To which I would repeat: Yet. We don't know what's going to happen to Franklin Raines and his lieutenants once everything comes out at Fannie Mae. The fact that no one has gone to jail yet doesn't mean much.
A hunch ain't worth a bunch
Nor does the following comment, made in response to a Sept. 29 Dow Jones report about more violations yet to be divulged: "New violations? I am skeptical, and so are many other knowledgeable people. In the two days that followed, analysts at the majority of the large Wall Street houses said this was old news."
That's a stunningly weak rationalization for one's position. Nothing more than, "I am skeptical?" No reasons to be skeptical? And citing the very dead fish whom you normally take the other side of as the core of your raison d'tre?
Next, he took issue with Armando Falcon Jr., who as the former director of OFHEO, Fannie's regulator, is positioned to have a pretty good idea of what may have gone on. Dreman criticized Falcon for his Oct. 11 op-ed article in "The Wall Street Journal," in which Falcon warned that if Fannie and Freddie's practices went unchecked, they could pose "serious disruptions to our financial system."
Dreman's complaint: "He doesn't say how, other than citing an obscure OFHEO report." Since Falcon ran OFHEO, the Office of Federal Housing Enterprise Oversight, he may have some knowledge that is more reasoned and closer to the truth than the dead-fish opinions cited by Dreman to buttress his skepticism about potential new violations.
I can't know for sure if there are more wrongdoings to come out or not. But when you look at the litany of potential problems and all the things we do know, giving the benefit of the doubt to the company seems rather unwise. But if you find yourself reciting these types of arguments to bolster your position, my experience tells me: You're probably on the wrong side.
When 'cheap' is skin-deep
What Dreman appears to fall back on is the "fact" that no matter what ails Fannie, it's okay, because the stock is cheap: "Fannie Mae trades at an estimated 6 times trailing earnings, giving you a margin of safety even if earnings are restated downward."
Because Fannie Mae hasn't filed its financials since June 2004, there is absolutely no way to calculate what its earnings are. But, thus far, we do know that Fannie Mae has at least $10.8 billion worth, or about $10 per share, of accounting "mistakes" -- and that more problems could potentially be disclosed. To rely on the stock trading at six times what Fannie said it made, when we already know that those numbers are not correct, is little comfort, especially when you consider the leverage on Fannie's balance sheet, not to mention its derivatives.
If it turns out that David Dreman was right to view Fannie Mae this way, that there is really no "there" there and that the company is sound, I'll have to admit that. And I will. But for the time being, it seems to me, the better argument belongs to the bears. Even if he's correct, I don't really see what the upside is, and there's no measurable margin of safety. That's why, if he's wrong, the downside could be quite substantial.
Innovation answers to competition
That brings me, finally, to Research in Motion (RIMM, news, msgs), maker of the BlackBerry, where the recent volatility has been rather dramatic. When RIMM pre-announced lower subscriber additions recently, it blamed the problem on the late rollout of a new product. To some degree, that's probably the case. I also believe that the potential for an injunction in patent dispute that could shut down most of its business has hampered its sales.
But more importantly, RIMM is being affected by all the competition lining up against it. It's one of the most vivid cases I can recall of a tech company making a great product and, after a sensational run, turning into a disastrous investment. Rarely in my career have I felt like I understood a situation so well and, more importantly, has the timing seemed so obvious to me.
But though I do have quite a good deal of conviction, I urge folks not to let that cause them to enter the fray. RIMM is an interesting case study to follow, in terms of technology and profitless prosperity. However, I believe that it is not for the faint of heart, nor for folks who aren't professionals. Deteriorating fundamentals aside, the stock could easily hand you losses even as it makes its way to single digits over time.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily "Market Rap" column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC or MSN Money. At the time of publication, Bill Fleckenstein was short Research in Motion and long Fannie Mae puts.
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