How many investors would be inclined to believe they had found the proverbial “sure thing” if they owned shares in the company described below? Following its initial public offering in late 1985, this NYSE-listed firm achieved steady growth in earnings and dividends, and the shares delivered an annualized return of 24.8% from January 1986 through December 1999 compared to 18.04% for the S&P 500® Index.
It cruised through the subsequent bear market without a scratch: total return for the three-year period ending December 2002 was 44.18% compared to -37.61% for the S&P 500® Index.
When the broad stock market recovered, it did even better, outperforming the S&P 500® Index by a generous margin in 2003, 2004, 2005, and 2006. Over the 20-year period ending December 2006, the firm’s shares outperformed those of Berkshire Hathaway (BRK) by over 450 basis points a year. With returns like this, who needs Warren Buffet?
The company had a well-deserved reputation for grinding out steady profits in a competitive business. Led by a hard-charging former scrap-iron salesman with no college degree, the firm relished its scrappy underdog image and, over its 85-year history, had a record of making money in both good times and bad. It studiously avoided expensive acquisitions that often created headaches for its competitors and focused on even minor details to improve profitability. A famous memo from a former chairman admonished employees to minimize costs by reusing paper clips and rubber bands.
Does this sound like a sure-fire winner most investors would be delighted to have as a cornerstone of their portfolio? If so, they have plenty of company. So did thousands of employees of Bear Stearns Companies (BSC) who saw their shares collapse last week as the firm narrowly avoided a bankruptcy filing and agreed to sell itself to JP Morgan Chase for $2 per share. A stated book value in excess of $80 per share including a modern Manhattan headquarters building valued at $8 per share offered little protection.
The firm’s swift collapse would have seemed unthinkable until very recently. A favorable cover story appearing in Barron’s in 2004 noted that “with the company’s low risk profile and strong controls, investors in Bear Stearns can sleep well, knowing that even a full-blown financial crisis is unlikely to cripple the firm.” As an example of these superior risk controls, the article noted that the firm didn’t suffer a single daily loss in its trading activities throughout the entire year in 2003. More recently, just one week before it faced the prospect of bankruptcy, the CEO stated in a press release that the firm’s “balance sheet, liquidity, and capital remain strong.”
In recent trading sessions, Bear Stearns shares have traded at a significant premium to the proposed acquisition price of $2, and it remains to be seen just how much BSC shareholders will ultimately lose. But even if the final liquidating value is quadruple the proposed figure, it would still represent a loss of nearly $19 billion in equity market value compared to its peak in January 2007 when the share price touched $171.
Approximately one-third of the shares are owned by Bear Stearns employees, many of whom now face the prospect of losing their jobs at the same time their investment portfolios have been decimated. A grimmer example of the dangers of exposing one’s human capital and investment capital to the same risk factor is difficult to imagine
Also in This Issue:
Gold: Shining Brightly After 40 Years
Health Savings Accounts: A Closer Look
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
Asset Class Investment Vehicles
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