Feeling Nortel's Pain

It wasn't long ago that shareholders of Nortel Networks (NYSE: NT  ) must have felt like they'd been taken to the woodshed. From above $80 in 2000, the stock plunged 99% before bottoming out in Oct. 2002. That's one big-time tanning of the backside.

Since hitting bedrock at less than a buck, the stock clawed its way back to peek above $8.50 per share in February, which includes a 120% gain over the last 52 weeks. The stock had trailed off of late, but shareholders couldn't have guessed what was to come.

Before today's open, Nortel announced that its president and CEO had been "terminated for cause." Those are three words you never want to hear because they always mean bad news. But it gets worse. Also terminated with cause were the chief financial officer and controller.

It only follows that results for 2003 will be revised and restated along with those of prior years, and that the financials will be filed late. In other words, what little shareholders thought they knew is not accurate, and where their company sits today is more in doubt than ever.

What were these shareholders thinking? They were praying that 4.3% operating margins would expand to 28% -- matching those of industry leader Cisco Systems (Nasdaq: CSCO  ) . They were hoping that $4 billion in cash would trump $3.9 billion in debt. What they got instead was a Trump-esque, "You're fired" -- a whole miniseries of them.

Likely, Nortel shareholders watched the progress of competitor Alcatel (NYSE: ALA  ) with a similar cash-to-debt balance or Lucent (NYSE: LU  ) with more debt than cash, and dreamed their stock could make it back at least above $10 a share. Instead, the stock plunged roughly 30% to $3.80 when trading started this morning.

The good news from here is a deal with Verizon (NYSE: VZ  ) to upgrade old switches (oh, the woodshed pun opportunities there). Sadly, there is also a formal SEC investigation to keep our minds occupied while we endure today's beating.

Contrarians claim they like to invest when blood is running in the streets -- well, it's running. Those who don't like the sight of blood should focus on quality management, strong balance sheets, and valuation. We can't always avoid trauma like we got with Nortel today, but an eye on these three goes a long way.

Management, balance sheets, and valuation -- three pages straight out of Motley Fool Hidden Gems . Take a spin for free.

Fool contributor W.D. Crotty does not own stock in any of the companies mentioned.