Late last year, when there was blood in the streets, a well known discount broker (Company A) was said to be on the verge of bankruptcy and the stock tanked 50% in one day. Not only did it tank 50% but the prognosis on the street, at least perpetuated by mainstream media, was that company was hosed and that they were going under. They didn’t have a rich history of being able to fight off adversity, they were relatively new in the financial business and lots of people figured they’d collapse. SIPC insurance would have to be initiated to save accounts and it was going to be yet another one of the casualties of the sub-prime mess. Would you have sensed that the market had panicked and bought shares? Or would you have joined the bandwagon and watched the shares fall into oblivion?
Now consider this scenario. Several months later, an 85 year old investment firm (Company B), well known throughout the world, looked to be royally screwed as traders were concerned that the firm wouldn’t be able to fund future transactions. Their lifeblood, capital, appeared to be bleeding out as investors were pulling out their funds in the firm. Until their last quarter, they had never posted a loss. That’s 85 years worth of straight profits. On a Friday, their shares fell 10% to a five year low of around $57. By Monday, they closed at $30 on those same credit concerns. Did you see this as the market offering a huge discount on a valuable commodity? Or did you see it as the end of pretty good eight-five year old run?
Well, if you guessed, based on the setup, that Company A recovered and that Company B didn’t… you’d be quite astute. You’d be more astute if you made those determinations as the events were unfolding, rather than right now. Company A was E*Trade, which was the impetus for a topic focused on what would happen if your brokerage went bankrupt. Company B was Bear Stearns. JP Morgan Chase recently announced that they’d buy the firm for $2.30 a share, with funding from the Federal Reserve. While the ink isn’t dry yet on that deal, it was announced this past weekend in conjunction with a weekend 25 basis point cut by the Federal Reserve (an event almost as rare as Halley’s Comet, the last weekend rate cut announcement was October 6th, 1979).
The moral of this story is that you shouldn’t even buy individual stocks based on (emotionally-charged) news. The broader corollary to that moral is that you shouldn’t buy individual stocks without careful inspection of its fundamentals, but avoiding emotionally-charged news is always a great first step.
For the record, I thought E*Trade was going under and Bear Stearns would be fine. I didn’t buy shares of either because I’ve been burned (and rewarded) in the past about ignorantly buying on bad news (now I stick to index funds like a good boy!). In the past, I bought Enron because I thought people were over-reacting but one can never underestimate the pervasiveness and severity of outright fraud. I was rewarded when I bought shares of Xerox in 2000 when it was in single digits because I figured a firm with that storied a history probably was going to make it (or at least be acquired). Though it’s like they say, tell your kid that the stove is hot won’t sear in the message quite like actually touching it.