What Could Go Wrong in 2003?

We can't pick winners every time, and Bill Mann is certainly a good example of that. Even before last year's Industry Focus 2002 shipped to our dear readers, the SEC was investigating one of his stock ideas for fraud. Oops! But he's not sour, and we've turned lemons into lemonade. This year, we've tailored Stocks 2003 to include safeguards against potential risk.

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By Bill Mann (TMF Otter)
December 18, 2002

There's a joke around the Fool office that I might as well let you in on. One of the big marketing ideas considered for Stocks 2003 was "10 Great Stock Picks, plus whatever Bill Mann comes up with."

Yeah, it would've been hilarious.

The sentiment doesn't come without historical reason, though. You see, the stock I selected last year was being investigated by the Securities and Exchange Commission for fraud even before Industry Focus 2002 shipped out. By March, it had become the first New York Stock Exchange stock in more than 20 years to be halted by order of the SEC. It now trades on the Pink Sheets at about a nickel a stub -- and I'm not even sure why they let it do that.

For those of you doing the math, that's a loss of 99.9%. Incredible.

The story of this company, A.C.L.N., is telling -- it also taught us that we needed to change our format. In the write-up about A.C.L.N., I highlighted, in general, every one of the risk factors that turned out to be in evidence at the company: an international business impervious to U.S.-based regulation, difficult-to-verify operations, poor corporate governance controls, faked numbers, and an extraordinarily high-risk profile. We decided in December 2001, as we watched in horror as what seemed to be a solid, conservative company unravel, that our next product would be responsive to such problems and explicit in its instructions about what to do about them.

We should all face facts: Everyone makes costly mistakes in investing. Ask Warren Buffett about his biggest mistake, and he'll tell you it was Berkshire Hathaway (NYSE: BRK.A). Before Berkshire was Buffett's investment vehicle, it was a struggling Massachusetts-based textile manufacturer. Buffett bought the company, thinking he could turn it around and make it profitable. Then reality stepped in and showed him his limitations. It was an expensive lesson, one to which he paid wry homage by retaining the name "Berkshire Hathaway" for his hugely successful holding company.

Successful investing doesn't mean being perfect. Successful investing means recognizing the risks, and if need be, responding to them. Our Stocks 2003 is The Motley Fool's way of offering a product that identifies the risks, as well as the opportunities. I'm convinced that each of the ideas presented in this volume is a good one -- but we should face facts: Some of them aren't going to work out as planned. So the big question in advance should be, "Why not?"

In Stocks 2003, we do our damnedest to tell you what could go wrong -- not just in the next year, but for as far into the future as we can foresee. Here's what you'll find inside:

  • A specialty pharmaceutical company is a definitive contrarian selection -- its core product was blindsided this past year with a controversy about a drug's potential long-term effects. But our analyst believes the stock has been knocked down to the point where the price assumes there's a definitive problem, as opposed to a potential one. Plus, the company has several unaffected products creating significant value, and though a certain therapy has come into question, the company's delivery system has not. It's not a low-risk company, but we give you clear signals that may indicate you should head for the door.

  • We highlight a casual-dining restaurant chain that offers reasonable growth. Its self-identification as a "destination" keeps its stores packed and its average check nearly 50% higher than at comparable restaurants. This company has seen cash flow generation increase to more than $2 million per outlet in 2001, and each new store pays for itself in less than three years. Our analyst cautions that investors need to pay special vigilance if the company should announce a new "concept." It did so back in 1996, with disastrous results.

  • One of the largest advertising/public relations firms in the world, this stock idea is predicated upon an eventual turnaround in the advertising business. The company's multiples to sales and earnings have yo-yoed along with the overall performance of the industry. This means the company is priced as if this "once in a lifetime" industry softness is somehow permanent. Further, this company has pledged to improve its operating efficiencies, upping profit margins on each dollar of revenue. This may not happen, and our analyst points out key ratios an investor should watch to detect signs of failure. Further, our analyst details a pivotal factor: It's possible that the advertising market will remain flaccid throughout the whole of 2003. Unless the company, itself, shows degradation relative to its peers, we're willing to be patient.

Finally, not all of the signals for sale are bad. More times than I'd like to count, we've seen stock ideas take off to dizzying heights within a year, only to come back to earth before the year is done. If the rise in stock price pushes the company's valuation beyond that which makes for a reasonable investment, our analysts would likely sell, content with the knowledge that his investment thesis worked out. In Stocks 2003, we offer the price points at which we'd recommend reviewing the underlying business of a stock.

And sometimes, companies that continue to do good things have lousy stocks over the short term. One company included in Stocks 2003 is a holdover from Industry Focus 2002, even though it's down by more than half. Why? Because nothing has changed, and if anything, the stock is even more promising than it was a year ago. You can be correct in investing and not reap the rewards on your own schedule. It just happens. If none of the risks have come to pass, an investor may be comfortable continuing to hold.

All in all, we'd like to come back at the end of 2003 and say, "All of our companies stomped the market!" Pretty unlikely, though. Instead, we intend to review each thesis to determine whether it worked. By so doing, we won't have to rest on the year-end returns to know whether we've provided something of value -- it will be much less arbitrary than that. And that's a good thing.

Fool on!

Bill Mann,
Stocks 2003