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The Stock That Burned Me: NETeller

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Worldwide Invest Better Day 9/25/2012

On Sept. 25, the Fool is celebrating Worldwide Invest Better Day. In this spirit, we Fools are sharing some of our best advice, tips, and, yes, cautionary stories. Sometimes, learning from someone else's mistakes is better than studying their successes.

Top growth in a top-growth industry
By 2006, the online poker explosion seemed to have no limits. Young stars made hundreds of thousands (and also lost a lot), never leaving their multiple computer screens in the comfort of their home. When the impossibly named online poker player Chris Moneymaker won millions at the World Series of Poker's headline event in 2003, the game's popularity shot into outer space.

And there was the PayPal of online poker: NETeller. Despite its less cash-intensive business model (no dealers or comely women offering free drinks to employ), unbelievable margins, and 50% to 100% annual growth rates, the stock’s valuation looked incredibly cheap in my mind. Price-to-earnings and price-to-cash flow multiples for NETeller hovered in the teens at the time, whereas many growth stocks of this nature are looking at 20, 30, or 40 times earnings valuations. It was a bank with the safe left open and the alarm off all night. Who cared about Steve Wynn and his ultra-luxury Wynn Resorts (Nasdaq: WYNN  ) properties on the strip, or the Bellagio, owned by MGM Resorts (NYSE: MGM  ) , with its gaudy Dale Chihuly glass sculpture? I went all in with the largest percentage of my portfolio I had ever committed to one stock.

I didn't see risks, only dollar signs. States had long since elected legislatures that instated lotteries when financial needs pushed long-held moral objections to the side. Federal law required states with casinos to allow in-state federally recognized Indian tribes to have casinos on the same or better terms. And prevalent legal opinion held that The Wire Fraud Act of 1961 applied only to sports betting.

Problem? What problem?

What went wrong?
Two things should have warned me. First, eBay (Nasdaq: EBAY  ) did not allow its PayPal unit to process payments to online gaming. Its lawyers saw more risk, but to me they were just teacher's pets. Hey, more dough for NETeller, right?

And second, anti-online-gaming forces had sought legislation since 1998 but had never won. And even with 2006's scandal surrounding connections between lobbyist Jack Abramoff and the on- and offline gaming industries, it was hard to see enough votes for action. Opinion held that Republicans would lose control of the Senate, and they were the force for change.. So, no problem.

Ah, but the Senate proponents had a weapon: the Safe Ports Act. Who was going to vote against an act to improve port security against terrorism? So in the dark of night, the Senate inserted into the bill a section banning financial institutions from transacting with online gambling sites, passed it, and watched President Bush sign it into law on Oct. 13, 2006.

Overnight, NETeller was on life support. It could not do business in its largest market, the U.S., without working with financial institutions. Worse, the Justice Department soon detained two former NETeller executives on money-laundering charges.

The company suspended trading in its shares in January 2007 and it reopened six months later off 64%. But I had paid a higher price, enjoyed paper gains, and then watched the shares lose a larger percentage. Paper and I? Both burned.

NETeller became Neovia, and today is Optimal Payments, traded in the U.S. through unsponsored ADRs. It's a microcap and has no earnings. The online gambling sites tried to tricks payment processors to keep at it, but finally the Justice Department ended the workarounds in April 2011.

Lessons learned
I had spent years honing my process as a value investor, but even with that discipline, I hopped into the NETeller stock sports car without a look back. It was a very profitable company whose stock offered growth at a very reasonable price --"GARP" with rocket fuel. It was so... sexy! Yet others do this investing well, but I didn't and still don't.

Folks, this wasn't mere style drift. It was a bloomin' style shift tsunami.  

So here is the lesson loud and clear: Be resolute. Whatever investing style works for you, stick to the process, and never go all in. Do not be Canadian humorist Stephen Leacock's knight, who got on his horse and rode off in all directions. Practice, practice, and practice. All we investors have are probabilities about an unknown future, but a consistent, repeatable process brings more wins than losses. Eventually, you reach the goal.

I've never chased a growth stock since and hope never to again. Please, if anyone even hears a peep from me that I'm about to do so, lash me to the mast, like Odysseus, to hear the seductive siren song of growth but not succumb. Sports car stocks are alluring, but they don't do well in crashes.  

Tom Jacobs is lead advisor for Motley Fool Special Ops, a premium service offering a long-short investment portfolio serving up special situations and opportunistic values, spiced with a dash of earnings quality shorts. He is the co-author with Motley Fool Alpha's John Del Vecchio of What's Behind the Numbers? How to Expose Financial Chicanery and Avoid Huge Losses in Your Portfolio. Follow him on Twitter @TomJacobsInvest.

Motley Fool newsletter services have recommended buying shares of eBay. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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