Stock promotions versus patience

Bonjour,

This week, I was reading yet another press article on a UK company called Quindell.

To me, this is clearly a stock promotion and it made me think of how some stock promotions can be so outrageously ludicrous that they are believed by many.

So to start with, we can take a look at some outrageous stock promotions.

A stock promotion can be a scam, a fraud, or simply a company where directors are inflating the prospects of the firm.

Often, earnings are overstated, prospects inflated, outlook optimistically worded while there is nothing behind.

I am quoting a few examples where it the fraud is so big that you cannot understand why it was not seen before.

ZZZZ Best Inc., 1986
Barry Minkow, the owner of this business, posited that this carpet cleaning company of the 1980s would become the "General Motors of carpet cleaning."

Minkow appeared to be building a multi-million dollar corporation, but he did so through forgery and theft. He created more than 10,000 phony documents and sales receipts, without anybody suspecting anything. 

ZZZZ Best went public in December of 1986, eventually reaching a market capitalization of more than $200 million. Amazingly, Barry Minkow was only a teenager at the time! He was sentenced to 25 years in prison.

Centennial Technologies Inc., 1996
In December 1996, Emanuel Pinez, the CEO of Centennial Technologies, and his management, recorded that the company made $2 million in revenue from PC memory cards. However, the company was really shipping fruit baskets to customers.

The employees then created fake documents to appear as though they were recording sales. Centennial's stock rose 451% to $55.50 per share on the New York Stock Exchange (NYSE).

According to the Securities and Exchange Commission (SEC), between April 1994 and December 1996, Centennial overstated its earnings by about $40 million. The stock plunged to less than $3. Over 20,000 investors lost almost all of their investment in a company that was once considered a Wall Street darling.

Solv-Ex, 1997

This oil exploration company cost investors nearly $1bn. Its CEO claimed that they had found a way to extract oil from bitumen sands in Canada at a much lower cost than then prevailing technology. Also, their technique would help recover metals from the sands that would otherwise be shed by older techniques, such as aluminium.

This stock promotion was supported by a then star fund manager of UK asset manager Morgan Greenfell: Peter Young.

The then £300,000 a year star fund manager was buying all the liquidity on the market to get the price of the stock up, until the SEC and the FBI started to investigate the company and its claims. Peter Young was fired for holdings inappropriate holdings and hiding secret buying of the shares via shell companies.

As the events unfolded, Peter Young started to lose his mind.

At his trial, he appeared in court wearing lipstick and a dress.

Subsequently, his behaviour became erratic: examples included a trip to the supermarket to buy 30 jars of gherkins. Eventually, the Oxford graduate began hearing voices urging him to change sex. His wife, said: "he started growing his hair long, plucking his eyebrows and waxing his body hair. He called himself Elizabeth”.

Let’s Gowex, Spain, 2014

More recently, last year, in Spain, Let’s Gowex was unveiled as a fraud and the company declared bankrupt.

For nearly 10 years, Spanish internet company Let’s Gowex SA said it was making money by providing public wi-fi in cities around the world. Most of the contracts, it now emerges, never existed.

The dodges behind his deception were surprisingly basic. To help cover his tracks, the CEO Garcia Martin reported fake revenues from shell companies owned by relatives and his housekeeper among others.

Once, one ex-worker said, Spanish officials wanted to check a project where Gowex claimed to have provided public wi-fi using four-wheel drive cars (in the Spanish countryside, cars would be driving around to provide internet connection at a cheaper price).

Garcia Martin used the Internet in his own car to make the project seem real. It was a Nissan Murano if you want to know. They are best for 3G signal ¦¦¦¦¦.

Other warnings signs included using an auditor working part-time from home (for a company with a $2bn market capitalisation) and having the CEO’s wife sign the accounts.

Also, the company boasted margins several times higher than peers and revenues several times higher than peers for the same service provided. That is because they were very efficient the professional research analysts said!

In conclusion, it is amazing to see how investors never learn!

There are many more stock promotions. The most famous recent ones are Enron or Worldcom (both revealed in 2001 and 2002).

Quindell PLC is one which would be amusing to tell about if savers would not lose lots of their hard-earned cash.

Stock promoters have sadly a great future in front of them. All this because investors want immediate returns and do not have patience!

Now for part two.

It is all about the value of patience.

Over 20 year periods, it is unlikely that stock investments will lose you money.

However, over 20 years, it is very likely that you will lose ALL your money in a stock promotion. 

Warren Buffett says it very well in his last letter to shareholders: 

The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.

Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.

It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.

For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.

If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may,

ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement. (The S&P 500 was then below 700; now it is about 2,100.) If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and

downs, to be sure).

Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.