Stop me if you've heard this before.
We've all seen it -- the world-famous go-getter laid low by scandal. It starts with a trickle of doubt. Is this person cheating on this single item? The skeptics circle. The true believers denounce them. More evidence arises. The press gets in on it. As the facts fully emerge, an entire enterprise unravels in a national disgrace.
Am I talking about Enron here? WorldCom? No, in this case, I'm talking about recently former South Korean stem-cell research hero Hwang Woo-Suk. His groundbreaking work in stem cells and cloning made him a global figure. Trouble is, we found out recently that his entire career was built on lies. The stem cell lines he had "created" were nothing more than lies and fudged "evidence" cleverly presented to a press and public that was all too eager to buy the dream he was selling.
It would be easy to write this off as just another case of a sociopathic egoist taking advantage of a gullible world. But I really don't believe that's how frauds like this one, Enron, WorldCom, or most others occur. I think the vast majority of them begin with decent but misguided intentions. "We'll just fudge things this one time." And when things don't get better, "We'll just say this," in order to cover up for that. In short order, an entire history of profits can turn into a web of deceit.
In our short-attention-span world, frequent results are measured as success, even if, or especially if, they sound too good to be true. We want to believe that the impossible is possible, and we're a lot more likely to swallow an incredible story if we think we can get a piece of the profits. That's how we all become fraud enablers.
The greater cruelty of the stock market is that you don't need to place your bets on an outright lie to get your money burned. Groundbreaking technologies that work provide an abject lesson into buying into big dreams at the wrong prices. Check the charts of Echostar Communications
Two steps for a safer portfolio
One of the best ways to keep your portfolio safer is to stick with companies that are in the business of selling old-school products that everyone needs. Perennially profitable bores like PepsiCo
But there's another way that's every bit as important: Never pay retail.
Insist on a margin of safety, even for the best business. And don't fall into the trap of paying the market rate ("too much") for all those exciting growth stories. Google may have a stellar business model, but at current prices -- much less the ridiculous $600 to $2,000 price targets being bandied about by fund monkeys out there -- there's no safety net for shareholders contemplating a buy.
The value way
"Safe, boring, and profitable" could be the motto for my colleagues at Motley Fool Inside Value, who take great pains, as I do, to avoid the market's greatest potential crashes-to-be, from frauds to mere high-fliers. Instead, lead analyst Philip Durell follows the simple path laid out by superinvestors like Buffett, Munger, Whitman, and Neff. He looks for unloved stocks that are trading at a discount to their intrinsic value, often boring cash cows like 3M
The flip side of fraud
Paradoxically, it also means taking advantage of the lighter side of fraud. If there's one thing more incredible than the heights to which shenanigans can take a stock, it's the depths to which companies can fall once the spit hits the fan.
That often leaves firms like Tyco International
subscribers were treated to a similar way to profit from the fallout of the U.S. market's biggest fraud, WorldCom. Philip Durell recommended WorldCom's wreckage, MCI, in the inaugural issue of Inside Value. That gave subscribers a 44% return in just six months when the reborn telcom was scooped up by Verizon
Of course, sometimes we buy the damaged goods too soon -- as in the case of Fannie Mae
For related Foolishness:
- Fraud isn't the only reason you should be terrified.
- Don't leave $20s blowing in the wind.
- Mistakes can make you big money.
- Learn more about finding dirt-cheap dream stocks.
Seth Jayson tries never to pay retail. At the time of publication, he had shares of 3M and Fannie Mae. View his stock holdings and Fool profile here . Tyco International and 3M are Inside Value recommendations. TiVo is a Stock Advisor pick, and Taser is a Rule Breakers pick. Fool rules are here.