FOOL ON THE HILL
Bill Mann speaks candidly about a significant investment mistake he made over the last few years: allowing his enthusiasm for telecommunications to get in the way of his ability to make a dispassionate analysis. It is human nature to take shortcuts when we are on familiar terrain, and this lowered caution can cause us to miss something big -- like billions of dollars of capital costs.
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"A mediocre idea that generates enthusiasm will go further than a great idea that inspires no one." Sometime I suspect my sole purpose on earth is to serve as a warning to others. I have made an investing mistake, one I intend -- for reasons of pride and financial fortitude -- not to repeat. And yet people constantly make this same error in every human endeavor; No doubt I'll be back at the confessional for the exact same reason some time in the future. My mistake was this: I allowed my experience and knowledge to be trumped -- and ultimately negated -- by my own enthusiasm and arrogance with regard to my investments. I have been so excited about my "circle of competence" that I forgot to actually take advantage of the competence part. In investing, we can get so excited about the prospects of a particular industry that the simple question "Does this make sense?" can be brushed over or, even worse, treated as sacrilege. It is entirely natural for people to get excited about their stocks and their portfolios. In many ways, portfolio performance is a validation of our own analytical abilities -- at least, it is when stocks go up. Pick any stock discussion board during late 1999 and you will find a preponderance of people who were convinced of their own genius. Heck, you don't even have to look that hard. Look at some of the Rule Breaker reports from late 1999, after the portfolio invested in Celera (NYSE: CRA) and the stock shot to the moon. That was an intoxicating validation, but ultimately one that had nothing to do with the actual prospects of the business or the Rule Breaker team's stock-picking ability. The affirmation that a rising stock price provides is heady stuff, indeed. We invest to make money, so when our investments go up, we are achieving. That's why it seems many are taking the horrible market of the last 12 months as a personal failure, not so much a loss of money as the loss of a dream and a dispelled notion of superior stock-picking skills. Everyone has done it. Everyone has ceded good judgment to eagerness at some point. How to know about an industry and still lose money Ah, but this isn't about stock market losses. You can be right or wrong about a company for years without having Mr. Market give his verdict. Where I missed the boat was in my original analysis. Essentially, I was right there with the cognoscenti in believing that the telecommunications industry would be the motor upon which much of the future would be staked. Essentially, I'm a card-carrying member of the "information technology will change the world" booster club. I still am, but I'm much more skeptical of most companies' ability to make money in the process, even though the clues for the poor economics of telecom were staring all of us in the face for years before anything bad actually happened to the sector's stocks. In fact, I had analyzed these companies quite thoroughly. I did my homework. But I did not check against one single assumption that had to be made for anyone to believe in telecom companies: the fact that all of them had huge capital costs and most of them were financing these with debt. Instead, I busied myself with making comparisons between various companies, trying to figure whether McLeodUSA (Nasdaq: MCLD) had a better strategy than Winstar (Nasdaq: WCII), or whether Qwest (NYSE: Q) would have a more robust network than Williams (NYSE: WCG). It was as if, on a long journey into the jungle, I dutifully avoided certain types of plants that would irritate my skin, only to ignore the fact that my tent had a tiger sitting in it. What I saw, knew, and managed to rationalize away through enthusiasm was that, for all of the technological differentiation carriers claim to have, their customers see a commodity product and force them to compete largely on price. Add to this hideous amounts of capital investment, and you've got a brutal industry in which to carve out a superior return on investment. And for a time, every bank, shareholder, and vendor seemed to be ready to keep the taps on and supply carriers with the cash they needed to continue to build. Investors willfully accepted secondary offering after secondary offering, convinced that once the buildout was complete the financial return the carriers would provide was enormous. It may well be, but I'm not so convinced anymore. Stock price performance has nothing to do with this skepticism, though it has forced me to re-evaluate my earlier assumptions. Much of what I needed to know about the risks facing telecom carriers was clear and evident before the wheels came off. One must only have asked: "What happens when the capital markets tighten up?" I did not. This is a common mistake among individual investors, but businesses do it as well. First Union (NYSE: FTU) acquired dozens of banks from the mid-80s onward, and in the process transformed itself from a small North Carolina bank into one of the nation's largest. And yet its final mergers -- with CoreStates Bank and sub-prime lender The Money Store -- both were unmitigated disasters, ultimately costing First Union hundreds of millions of dollars. First Union, being a bank and an experienced takeover artist, had the institutional know-how to make a dispassionate analysis of CoreStates' and Money Store's businesses, yet missed some tell-tale signs that all was not well with its dance partners. One popular notion is that the culture of First Union rewarded its managers for the numerical value of a deal rather than the fiscal sense of one. In the drive to get the deal done, no one had reason to stop to ask whether the deal should be done in the first place. Thus, they ventured into the jungle having been there many times before -- and fully equipped with mosquito netting, maps, and compasses -- and still made exceedingly bad deals. While the dollars we are dealing with are generally lower than those involved in a bank merger, our own enthusiasm can serve not to help us make good decisions, but rather to make cognitive mistakes in our own analysis. The investment world is a jungle that can turn nasty in a moment. All the preparations in the world will not help if you are unable to use your knowledge to your advantage. Got a viewpoint? Bill Mann's blues name is Asthmatic Lemon Jefferson. At the time of publishing, Bill had beneficial interest in Qwest and First Union. To view his other holdings, see his profile. The Motley Fool is investors writing for other investors.
-- Mary Kay Ash
Emotion is not your friend when it comes to stocks. "Home Court Advantage" can also hurt you if you replace dispassionate knowledge with unchecked enthusiasm. In my case, having come to The Motley Fool from a telecommunications company I felt that I was in a pretty good position to analyze these businesses. And I am. But that didn't stop me from getting shelled over the last year due to a rapidly changing marketplace in which telecoms, from top to bottom, dropped precipitously in the market.
Have you missed the investing boat in an area you know a lot about? Come share on the Fool on the Hill Discussion Board!
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