Most of us were more than happy to say good-bye to 2001, and we're all looking for better things in 2002. As investors, it's always great to start with a clean slate, especially after two consecutive down years in the market. But we don't want to forget about the past entirely, because history always provides us with valuable learning opportunities.
In that spirit, let's take a look at a couple of stocks that were among the best- and worst-performing small caps in 2001, and see if we can glean a valuable lesson or two from them.
To come up with our version of the worst-performing small cap, I ran a screen with just three variables:
- Market capitalization below $1 billion
- 2001 revenue below $500 million; and
- Percent price change in 2001 as low as possible.
The first two variables were simply designed to limit our companies to small caps. The $1 billion cutoff was entirely arbitrary on my part, and the $500 million revenue cap comes straight from the list of Foolish Eight criteria.
Here are the five worst-performing small-cap stocks of 2001, then, as provided by my extremely unscientific screen:
Company 2001 return 1. Brokat Aktiengesellschaft Ads (OTC: BROAQ) -97.5% 2. iAsiaWorks (Nasdaq: IAWK) -97.3% 3. CoreComm Limited (Nasdaq: COMM) -96.8% 4. Pinnacle Holdings (Nasdaq: BIGT) -96.2% 5. Classic Vacation Group (AMEX: CLV) -96.2%
I eliminated Brokat Aktiengesellschaft for our purposes, because it's a German outfit and information for it is hard to come by; it's not likely a company we would have considered buying in the first place. It collapsed under its own debt load in 2001 and filed for bankruptcy. (Also, I can't pronounce the doggone name.)
I dropped iAsiaWorks and CoreComm from consideration because each was trading under $5 last January, and as Foolish investors we likely would have avoided them also. The same goes for Classic Vacation.
Pinnacle Holdings will work for us, however: It began 2001 around the $9 mark, and like a star in the latter stages of its life it flared up briefly above $12, then started a slow and steady descent, and has now almost completely collapsed in on itself... trading at just $0.33 a share.
Pinnacle's business is fairly straightforward: It rents space on communications sites -- such as towers -- to providers of wireless communications services. Its "tenants" include such names as BellSouth (NYSE: BLS), Motorola (NYSE: MOT), Nextel (Nasdaq: NXTL), Skytel, Sprint PCS (NYSE: PCS), and Verizon (NYSE: VZ), as well as the FBI and the Bureau of Alcohol, Tobacco & Firearms.
Pinnacle's tenants are generally responsible for the installation and maintenance of their own equipment on the sites, and its business scales well because each added customer requires little in the way of incremental costs.
Potential investors may have eyed Pinnacle as a "bargain" last January. It announced in August of 2000 that it was under SEC investigation for improperly accounting for the acquisition of Motorola's North American antenna site business in 1999 and the stock fell from roughly $50 in August to $9 by January of 2001. During that period, management said it was fully cooperating with the SEC to get the matter resolved as quickly as possible.
It's always easy to point out things in hindsight, and I know there were a lot of people agonizing over this stock early last year, wondering how it could go any lower. But I'll bring up our first valuable lesson here from Pinnacle's fall, and it's a rule I try to follow personally: As soon as hints of impropriety begin to surface, especially when the SEC is involved, sell the stock. (Let me state here that I'm not talking about rumors spread by short sellers or others with a financial interest in the stock.) Time after time I've seen companies hit hard after bad news like this first comes to light, only to fall even dramatically farther in the ensuing days and weeks.
Sure, maybe there's an exception to this rule now and then, but I'll bet you can think of a lot more instances where a company continues to lose significant value well after such news first comes out. For me, it's just not worth the time and energy to continue to hold the stock and sweat through SEC investigations and the like when there are so many other investments out there to consider.
Just a month ago, Pinnacle settled with the SEC and received a mere slap on the wrist. Without admitting or denying guilt, the company agreed to the SEC's order to "cease and desist from committing or causing violations of the reporting, books and records, and internal control provisions of the federal securities laws." No fines or any other punishment were imposed.
As we've seen, though, that favorable settlement with the SEC did not help the company at all during 2001. In March, chief financial officer Jeffrey Card resigned. Class action lawsuits were filed, alleging that executives misled investors as to the company's business and financial condition. The investigation weighed down Pinnacle so much it had to cancel plans for a secondary offering, and it admitted it was "unable to access the equity and debt markets on attractive terms." Additionally, management restated some past financial statements... a move that had little impact on prior earnings but rattled investors nonetheless.
My point is best made by Pinnacle itself in the company's most recent 10-Q: "We cannot predict the outcome of the SEC's investigation. Regardless of the outcome, however, we have incurred substantial costs and the investigation has caused a diversion of our management's time and attention." For small companies, especially, this kind of diversion can be extremely damaging.
There were some other signs to warn away investors, as well. The 10-K issued in April raised a red flag about the churn rate (the number of customers discontinuing business with Pinnacle) and pointed to a possible technological sea change that could negatively impact business: "We experienced a level of churn by our tenants in 2000 that was higher than our historical level of churn due primarily, we believe, to changes in certain customers' underlying communications technology resulting in a decrease in their need to retain their equipment on certain of our towers."
All in all, while it may have been tempting to buy Pinnacle at "bargain prices" during 2001, its trials and tribulations illustrate why it's best to avoid companies, especially small caps, that have their resources tied up in non-productive matters.
That's all the time we have for this week; next Monday we'll take a look at our best-performing small cap of 2001, PEC Solutions (Nasdaq: PECS). Why not familiarize yourself with the company ahead of time, and let us know what signs we could have seen early last year that PECS would flex its muscles and return 362%? Post your thoughts on our Foolish Eight discussion board, and I'll reprint some of the best ideas in Monday's column.
See you next week!
Rex Moore salutes another of his former schools, Anderson High School in Austin, Texas. Go Trojans! At the time of publication, he owned no companies mentioned in this article. The Fool's disclosure policy is still on the New York Times best-seller list (at #23,677).