BE SCARED OF FEAR
June 27th 2008 00:00
Listen boys, and listen good! Tis here is the real world, better know exactly where y er goin n ya better know how ya get there!!!
I suppose the difference between the battlefield and the marketplace lie in the nature of business you will find yourself in. In a physical, bullets flying, grenades and bombs exploding war, the competition is trying to get you killed. In such a situation, you can study the battlefields, your enemies and all the books in warfare and you still cannot tell if you will live in the end.
In the marketplace, the results, whatever they maybe will not be as sinister. So, you study the battlefields (macro/micro economics), the protagonists (companies) and you design your game-plan (trading systems/strategies) and whatever happens, you will still be physically safe (unless you die of cardiac arrest because of fear). The risks, naturally, will be there. When the dice stops rolling, you might end up losing – but you will still be standing (alive, I mean).
Hey bro, did you hear what the man said? Seems like we're in the wrong place!
But that is not the good news. The good news is, in the stock market, you can keep the dice rolling for as long as you can repel fear. The longer the dice rolls, the more time those people, who are working their butts off to make you money, will have and (therefore) the more chances you will get in beating the odds. That’s why some experts are saying: “the longer your investing horizon, the lesser is your risk.”
But what happens if, you have the longest investing horizon anyone can ever have, you studied the economy (macro and micro), you have the nerves tougher than steel and you did the whole-nine-yards and the companies you have chosen still failed?
Sure, you know what the financial advisors are saying about “mental stops”, the percentages they are suggesting you should watch so you can cut your losses, but still… won’t you just be throwing the towel too early?
Anyway, the real question is this: What is the worst that can happen to an investment? One has to know the answer to that if one is to conquer fear, right? And there has got to be a simple answer, somewhere, right?
Well… bad news: There is no simple answer. But there’s good news, too! What is the good news? There is no simple answer, either!
Whaa…t?
Uh, before you start cursing me, let’s put the blame on some economics professors who taught us that the safest answer to a question is always… “It depends” shall we?
Now, a discussion of that point is the reason for this post (more like an excuse to bring up this topic, really!).
Here’s a case in point. It is about a real listed company (and a big company, too!) that lost a lot of its own money and that of its investors that presents a nice example for this discourse. Chris the phil foreignerinvestor who commented in our post last June 25, 2008 might recognize the company since he plays the PSE market, but I will try to hide its identify by changing some of the details of what happened, but not the general incidents. Let’s call it the company B.
Company B is part of a diversified giant with business interests in several countries in Asia. In the Philippines, its sister company is a leading player in a very important industry – always beating its competitions by a mile, at the very least, and the gap keeps getting wider every year.
Company B and the sister company are high profile companies. They have big capitalizations, both are major players in major industries and both are listed companies. Unlike its sister, however, Company B suffered losses and it was not able to recover. The price of its shares dropped considerably low and stayed there for quite sometime.
Company B was, of course, carrying the reputation of its sister company and that of their parent company overseas and many of its investors thought that it can still pull out of the rut it was in, given time. But it wasn’t able to. It was engaged in capital intensive businesses that kept bleeding Company B's finances.
Worse, one of its major exposures was in an industry which is being killed by another industry where the major players can charge lower rates for a similar service that Company B provides, (though not exactly the same service) like in the case of shipping and airline industries.
Eventually, Company B had to fold up. Soon Company B will cease to exist. And it did.
What happened to the shares of stocks that were in the hands of the private investors?
Well, this is where that magic answer “It Depends” will come into play. From here on, what happens to those shares of stocks will depend on what is going to come next.
If the board of directors of Company B decided to liquidate the company, the share holders will get their “share” of the proceeds of the liquidated company. Preferred share holders will be the first in line to get paid, and the common share holders next. That is, if there is anything left after the preferred share holders had been paid. You can’t, of course, expect to get the full recovery of your investments, if you ever get paid.
But the situation is not always that grim. There are companies which assets are worth far more than their businesses are worth (as in, “the sum of its parts is greater than the whole” not the other way around). That however, was not Company B.
The board of directors of Company B decided to dissolve Company B. But they also decided to set up another company that will take over the assets and liabilities of Company B. Let’s call the new company “Company C.” (I know, very creative company names, eh?)
Company C took over the assets and absorbed the liabilities of Company B and decided to keep its loyal shareholders. To do this, Company C offered to exchange the existing shares of Company B, which were still in the hands of private investors, with that of Company C. Company B shares were last traded at P3.00/share while Company C shares were introduced with a Par Value of P1.00
The proposed ratio was two (2) shares of Company C plus one (1) Warrant for every share of Company B. The Warrant has an exercise price of P1.00. Not bad if you consider that Company B shares are practically getting exchanged at the rate of 1 Company C share for every 1 Company B share. Except that there is that business of the Warrant.
Company C shares started slow in the bourse, but it soon inched up to P2.00. It peaked somewhere above P5.00 before the subprime mess and is now hovering around P3.00
I am not Nostradamus, so I do not know how our little saga of “failed investments” would end. But right up to this point, our former Company B investors are not exactly at the losing end of the deal (depending on how much they bought their original shares). Still, Company C shares were already being priced at P6.00 by the head of investment banking of a big local bank before the world markets started going down the pits.
Now if those investors exercised their warrants at P6.00 (supposing the markets did not crash) they would have actually ended up with the equivalent of P17.00 for each of their Company B shares! Not really something to be sad about, as far as the original Company B shareholders are concerned, is it?
So, what was it again that we were so fearful about?
Here is a caveat, though. Not all losing investments turn out as nicely as this one. A friend of mine who bought the IPO of a fast growing retail company many years ago is still wondering when he will recover his investments, if at all. But the thing is, the retail company still exists (though already limping badly) and he still has the shares of his much diminished investment.
Now, do we really need to be so afraid (to the point where we do stupid things or develop heart ailments or any other diseases related to chronic worrying and fear) when the market or our investment crashes?
Or is it fear that we have to be wary of?
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