Lessons Learned From My 3 Worst Investments
Source: Flickr user David Goehring.
"Never stop learning, because life never stops teaching." -- Unknown
If there's one lesson to be learned when investing in the stock market, it's that it's impossible to be right 100% of the time. Motley Fool co-founder Tom Gardner astutely points out that a successful investor is only going to be correct about 60% of the time. The key is in focusing on the long term and allowing your biggest winners to run. This is one reason why Tom and his co-founder brother, David, have recommended the likes ofDisneyand Netflixin their flagship Stock Advisor service that are up 5,700% and 4,800%, respectively.
I can't say that I've had any four-digit percentage gainers throughout my 17 years of investing, but I do have quite a few investments that have returned a triple-digit percentage for me. Unfortunately, and on the flip side, I also have a bounty of some very bad (in hindsight) investments.
The goal of an investor is to learn from his mistakes. While learning doesn't guarantee we'll never lose money on an investment in the future, it does help us refine the weeding-out process when it comes to researching companies to invest in.
With that in mind, and in the spirit of community and learning, I'm going to share my three worst investments over the past 17 years (at least those that I can remember), discuss what went wrong, and share the lesson I eventually walked away with from each trade.
Source: Federal Reserve Bank of NY via Facebook.
CIGNAcalls You'll have to forgive me if I don't remember the exact dates for these trades, but I clearly remember the loss I took from call options I purchased on health insurer CIGNA roughly eight years ago -- it was a whopping 100%.
The thesis behind purchasing those calls was simple: It was earnings time and I expected CIGNA to surpass Wall Street's estimates. If I recall correctly, CIGNA had topped those estimates in each of the past four quarters, and its stock typically responded well come earnings time. I purchased these calls two days before CIGNA was set to report.
The result was nothing close to what I expected: CIGNA wound up missing Wall Street's estimates and updating its full-year guidance to the downside. The following day my options were worthless.
The lessons learned: First, I got a great reminder with this trade that the majority of options traders are going to lose money. This doesn't mean options can't be a great hedge against an investment, but going all in on a stock via options alone is not often going to be a prudent idea.
More importantly, I learned the value of trying to time the market and how unpredictable things can be. I expected to be in and out of my options in a matter of days. Instead of truly examining CIGNA's long-term prospects and its catalysts, I merely allowed a few headline figures to influence my investment -- and I paid for it big time. Long story short, I now head into my investments with a minimum horizon of one to three years.
Artificial Life stockAnother major red mark on my trading record is Artificial Life, an over-the-counter stock that created apps for iPhone users.
My initial interest in Artificial Life was sparked in 2009 when apps for the iPhone were all the rage. Artificial Life was profitable, and a number of its games were within the iPhone's top 25 most downloaded in 2009 and 2010. But the good times wouldn't last long, and I ended up taking a 90% bath on my shares despite averaging down a couple of times.
Ultimately, Artificial Life wound up announcing a completely new business model (despite making money on apps, mind you) where it would become a private equity investor in app development companies. In other words, instead of making the apps, it wanted to be the company that funded the developer who made the apps. Artificial Life went from modest profits each quarter to loss after loss. Shares are still listed on the over-the-counter boards for $0.01!
The lesson learned: The big lesson learned here is that micro-cap stocks, and/or those that trade on over-the-counter exchanges, come with notably higher risks than stocks listed on reputable exchanges, such as the Nasdaq or NYSE. In all fairness, the over-the-counter exchange is doing its best to clean up its image and the reporting status of the companies listed on the OTC, but as a whole it's a lot tougher to get accurate information on publicly traded OTC stocks than stocks listed on a reputable exchange.
In Artificial Life's case, once it began listing on the OTC boards, it no longer was required to regularly report its quarterly results. As soon as it stopped issuing quarterly updates, shareholders lost all ability to decipher the company's cash position, losses or profits, or even what sort of deals it had in the works. The lesson learned is that if you dabble in OTC or penny stocks, you should be prepared to be burned.
Source: Federal Reserve Bank of NY via Facebook.
Tower Group stockLastly, I saw more than 70% of my investment evaporate in insurance company Tower Group, which was acquired for $2.50 per share in 2014, well over 90% below its highs from just two years prior.
The thesis behind investing in Tower Group was based on my belief that insurers were always profitable. Unless a major catastrophe hit, insurers regularly pulled in enough in premiums and via investment income to turn a profit. Plus, insurers have exceptional pricing power and can pass along premium price increases to its plan holders. With Tower Group trading below its book value and sporting a single-digit P/E, the investment seemed like a no-brainer.
Ultimately, it proved to be a very poor investment. Tower Group had acquired a number of businesses throughout the years that wound up straining its balance sheet. A review of its capital requirements turned up the need for hundreds of millions in extra financing. Despite multiple cash raises, it became clear that Tower Group's prospects were limited as its ability to underwrite additional business came to a grinding halt.
The lesson learned: The lesson here is that a fundamental change in a company's business model is something worth avoiding.
I dismissed the initial problems with Tower Group as being a one-time event and simply assumed that as an insurer it'd be able to pass along premium hikes to begin working its way back to greatness. This proved not to be the case, with Tower's underwriting ability seriously compromised and shareholders getting whacked with common stock offerings in order to raise cash.
The article Lessons Learned From My 3 Worst Investments originally appeared on Fool.com.
Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool owns shares of, and recommends Netflix and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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