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The Stock That Burned Me

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.

It all seemed like such a good idea at the time. At the height of the tech bubble in late 1999, I made the worst investment of my career. The company was MGI Software, but don't bother searching for the stock ticker -- the company is long gone. However, back in the halcyon days of high-flying Internet stocks, it promised a "must-have" technology for an ever-more graphical web.

Essentially, MGI's technology allowed the viewer to zoom in and manipulate any graphic image on a website. This may be a fairly standard technology now, but at the time it was pretty revolutionary. I was entranced by the notion that online marketplaces (Nasdaq: AMZN  ) and eBay (Nasdaq: EBAY  ) would undoubtedly want to incorporate such technology so as to better present their goods to customers, to say nothing of real estate agents giving virtual "showings" of their listings.

My thesis: MGI was going to make a mint licensing the technology, or accepting a buyout from a graphics company like Adobe. Either way, I figured I'd make a good amount of money.

So what went wrong?
While I fantasized over the pretty pictures the company's software could present, I chose to ignore that, like so many of its technology peers of the day, MGI was in serious "cash burn" mode. I rationalized that this was temporarily OK because the company was going to launch a secondary offering on the Nasdaq (a Canadian company, MGI traded only on the Toronto Stock Exchange at the time) to continue financing its growth.

Then came March 2000, the top of the Internet/tech stock craze. As market gravity reasserted itself, MGI fell alongside its high-priced cash-burning peers. I'd originally purchased shares around $35. It got about as high as $40 before commencing its fall. A few weeks later, with the stock at $11, the Nasdaq secondary offering was shelved as management deemed the current price too cheap. Presumably, they believed the downturn surely would soon end, and they could reintroduce their plan to sell new shares at that time.

It was a fatal mistake. The price never came back, as there was no cash generation at the business level to support the stock price. With North America moving into recession, the ultimate insult was that the company was eventually acquired at a price under its then-trading price, but, with no other (reasonable) way of financing themselves, MGI had to take the lowball offer.

Lessons to learn
Cash is king: A company that cannot finance itself is beholden to the whims of outside financing -- in this case, the good graces of a market willing to buy more shares at a high price. When that willingness dissipated, so did the company.

Beware "bet the company" moves. MGI's management essentially placed the future of their company on eventually being able to sell more shares. If they had carried through with their original plans to sell more shares -- even in the mid-to-high teens -- they may have had sufficient cash to weather the storm and eventually better control their fate. Instead, they essentially wagered that the stock market would rebound before they ran out of cash.

This one's all on me, but don't be afraid to sell when things take a turn for the worse -- even if you're selling at a loss. I had ample time to exit in the high teens/low $20s range. The company's need for additional financing was not unknown to me. And yet, I anchored on the price I'd paid, and, in the process, committed one of the great mistakes of investing: implicitly saying to myself, "I'll hold and sell when it goes back to what I paid for it."

Stocks don't care what you paid for them; underlying fundamentals matter, and never more than during times of market crisis.

The bottom line
MGI ultimately turned into a 99+% loss for me, due both to its fall and to the subsequent fall of the acquiring company. While that money is gone, the lessons learned are useful for a lifetime. On balance, it's likely inexpensive tuition.

Jim Gillies does not own shares of any stocks mentioned. The Motley Fool owns shares of Motley Fool newsletter services have recommended buying shares of, Adobe Systems, and eBay, as well as creating a diagonal call position in Adobe Systems. 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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