Or Feet on the Trading Room Floor?

– Tales of Emotional Investments – 

Some people will lose everything before they accept a loss…

Bill McGilton, Editor and Financial Analyst

It was 2001, and I was a new attorney working on an antitrust case.

At the time there were no smartphones, and for security reasons, my colleagues and I had limited access to the Internet. So almost every day after lunch, I would stop up the street at the Charles Schwab office to check the market and my positions.

I wasn’t the only one. Several of my colleagues also stopped by daily to check their positions. Schwab had one streamer terminal available to the public and let customers add their positions to the list.

Because of our daily lunch visits, the stock market guys in my office came to know each other… and just about all the positions each one was holding.

In September that year, one of my colleagues was excited about a new stock purchase. He was able to buy this stock around $30, when only a year before the stock was trading around $90… three times higher.

It was one of America’s top 10 biggest companies when my colleague made his initial purchase. Wall Street analysts were still singing this company’s praises. One well-known bank even had a price target of $74 per share… So, he thought he was getting a good deal.

By mid-October – around a month later – the stock had dropped to around $15. Where others might have sold, my colleague stayed the course. He bought more. It was just too good of a deal… So “good,” he started selling other positions in his portfolio to put more money into this stock. He was sure he’d be a big winner.

He also seemed shocked that the rest of us weren’t taking a position. But by this time, bad news started to leak. We kept telling him to slow down. That something was brewing behind the scenes. But he wouldn’t listen.

By mid-November, the stock was trading for a little less than $10… And he went “all in.” He sold all his positions and “margined” his account – borrowing money against the value of this one stock – to buy more of the same stock.

It wasn’t long before he started getting margin calls. That’s when you must add additional money or securities to your account or your broker starts liquidating your positions.

By December 2 – less than three months since his initial purchase – the stock he had gone all in on declared bankruptcy and was trading around $0.30. My colleague’s entire portfolio was wiped out. And to make matters worse, he still owed his broker over $70,000 for the margin that he borrowed.

In the end, my colleague had liquidated his entire portfolio and life savings for a company that was “too big to fail”… That company was Enron, one of the largest bankruptcies in U.S. history.

Vaccines and valuations…

Dave Lashmet, Tech Analyst and Researcher

My first success in biotech was with vaccines, with a company called ID Biomedical. Things got so dire for this firm, the CEO was putting lab supplies on his credit card. But it had great scientists – whom I met with regularly – and doctors trusted their trials and research. The company was also well-connected in public health circles, giving it a head start in developing the first SARS vaccine.

As its fortunes improved, the firm went into growth mode and bought a flu-vaccine production facility. I was the first visitor, and I was shocked that other investors would short or go long without walking this factory floor or doing their own research… In vaccine circles, this company was top of the heap. Eventually, GlaxoSmithKline agreed and bought out ID Biomedical. As a recommendation in my biotech-focused newsletter, we made 333%.

Despite its strong track record and the support of the medical community, I’m sure there were emotions on my part… SARS was a fast-traveling, potentially lethal virus. And without a vaccine, the flu could easily bring down older folks. I wanted there to be solutions. Fortunately, I had both outside medical experts and a proven, effective drug on my side… the same things that convinced GlaxoSmithKline to buy ID Biomedical, regardless of Wall Street’s math.

‘It’s time to short the whole market…’

Turney Duff, Author and Former Wall Street Trader

When I worked on Wall Street, I used to take a walk around the office on slow days when portfolio managers and analysts had their guard down. When the office was quiet, people felt a little more at ease and often talked stocks casually. What they didn’t know was that I was secretly taking notes…

These guys weren’t emotional when their screen flashed green or red… When I would ask them about a particular stock, they focused on fundamentals, not price. It was these unfiltered ideas and thoughts that were the genesis for some of my best trades… They’d give me their dream scenario for stocks they loved.

And yet, whenever those stocks drifted to those prices, they wouldn’t pull the trigger. They became emotional and often questioned their own logic and research. When this happened, the first thing I would ask is if anything changed fundamentally. If not, I was ready to pull the trigger and start buying or selling based on our prior conversations.

This came in handy during the summer of 2007. Scrolling across the tape was an announcement that a nine-year-old Daimler Chrysler merger was falling apart because of financing. Remembering my notes, I stood up and screamed, “It’s time… It’s time!”

My portfolio manager had no idea what I was talking about…

Earlier that spring, we were in the midst of a flurry of merger and acquisition activity. It seemed like every morning we came into the office there had been four different takeovers the night before. I’d never seen anything like it. I knew my portfolio manager wanted to be short the market, he just didn’t know when. That afternoon he made an off-the-cuff remark, “You know, the next time one of these deals falls apart because of financing, it’s time to short the whole market…”

Standing up at my desk, I reminded him of his earlier prediction. Surprisingly, he wanted to dismiss it. The market was just “too strong.” In hindsight, we were fortunate enough to start the process of getting rid of lukewarm holdings and finding some new stocks to short… Months later, the Great Recession had begun and the market was anything but strong.

Did his off-the-cuff remark predict the inevitability of a coming crash?

No… But it motivated us to re-evaluate our holdings – without emotional bias – several months in advance.

‘I think we found the next Michael Jordan’

Austin Root, Analyst and Portfolio Manager

When the story changes, you sell…

I learned this lesson from a talented teacher. A man with vast investment knowledge. Because he’s an intensely private person and would prefer to remain nameless, I’ll simply refer to him as the “Guru.”

The Guru is an investing wizard and billionaire. He’s equally adept at making money during both bull and bear markets, as well as nailing investing from a top-down, macro perspective and a bottom-up, fundamental one.

Over the years, the Guru has made an absolute fortune investing in Nike. Early in the company’s history, most folks saw it as a textile company that sold sneakers… But not the Guru. He recognized Nike’s potential for success: The company wasn’t simply selling shoes… It was selling aspirations – a chance to be the best. It was building a brand that honored great athletics.

Most important, its brand was championed by the greatest of athletes. Nike knew that to be the “Michael Jordan of brands,” it needed Jordan to endorse its products.

The Guru first invested in Nike in 1984, for less than $0.20 a share (split-adjusted). Today, shares trade for more than $80. As of last year, the Guru still owned Nike shares, meaning he’s sitting on a total return of at least 40,000% from his initial purchase.

But that was just the beginning…

In Nike, the Guru saw a formula for success that he thought could be repeated: Identify an iconic brand with leadership that “gets it,” invest early, and then – so long as the story doesn’t change – hold on as the stock powers higher and higher… Then rinse and repeat with the next great brand.

So the Guru set out to find the world’s promising, future best brands. He spoke with CEOs and investors he admired, pored through financial data and reports, and interviewed scores of young people… research that led the Guru to athletic brand Fila. And in Fila, he saw an opportunity for history to repeat itself almost verbatim.

In fact, when the Guru decided to invest in Fila, he told his team, “I think we found the next Michael Jordan.”

At the time, Fila was a small, fast-growing athletic brand from Italy. In the late ‘80s and early ‘90s, its products began to catch on with popular rap and hip-hop artists and as they went mainstream, so did Fila. By 1993, the company was public.

But Fila wanted more. It wanted to use its urban “street cred” to break into the suburban markets the way Nike and Reebok had done. So in 1994, the company made its boldest move yet: It outbid Nike and signed an endorsement deal with up-and-coming basketball superstar Grant Hill.

Of course, with the benefit of perfect hindsight, we now know that Hill was no Jordan – either on or off the court. But in 1994, many thought Hill could be bigger than Jordan… And he was coming to the market after Jordan had paved the way and made basketball (and sneakers) more popular than ever.

The Guru knew this and knew how important a great basketball shoe could be. He had seen firsthand how the “Air Jordans” propelled Nike’s brand. So when James, a young man in his mailroom, confirmed that he and all his friends were buying the new Grant Hills, the Guru bought truckloads of Fila shares… and the bet paid off.

Hill’s first shoe sold more than 1.5 million pairs, which at the time made it the best-selling sneaker launch since the first Air Jordans. And after Hill won Rookie of the Year honors, his second shoe sold even more pairs. Fila’s market share went from seventh in the industry to third in just two years. The company’s stock surged even higher, going from the teens to more than $100 per share.

But right around the time Fila debuted the “Grant Hill III” third-generation sneaker, the Guru noticed something troubling… Fila’s shares had stalled out. When he checked in again with James, he was disappointed with what he heard…

When it came to playing basketball, the shoes were a bust. James and his friends had moved on… back to Jordans and back to Nike.

The Guru didn’t want to believe it. He dug deeper, did more research, but deep down he knew the story had changed. Fila had lost its gritty edge, pushing too far into fashion to grab a share of the suburban wallet. As painful as it may have been to give up on his thesis – one that had worked before and made him a fortune – the Guru sold his shares.

Sure enough, Fila began to struggle shortly thereafter. Rather than flying off the shelf at more than $100 per pair, the shoes were severely discounted and barely selling. Then, it got even worse. James told the Guru that “no one” was wearing Fila anymore, not even the older-model shoes or related athletic gear.

In 1998, the company’s U.S. sales fell 49%. The once-profitable company lost more than $130 million. Shares cratered, falling from a high of more than $100 in 1996 to the single digits. In 2003, vulture investor Cerberus acquired the company for a little more than $1 per share.

The Guru shared this story with me as it was playing out in the late ‘90s. He told this story not to gloat, but to convey a powerful lesson as vividly as he could: that in certain instances, a long-term “buy and hold” investor must sell… like when your initial thesis and the primary reason for investing in a company is no longer valid… no matter how many times you’ve been “right” before.