6) Investment - U.S./CH, 1998: miscalculated greed

Compelling event

    In 1996 Lucent Technologies was spun off from AT&T, soon to hit a high of $84 a share. I inherited 3,000 shares. The shares were "found money" for which I had not worked. Therefore I paid very little attention to them, as opposed to my private portfolio, established with monies I had earned. Lucent Technologies went into free fall. I was well aware of that, but assumed it would come back.

    At the time I was teaching an investment course. A three man team of superior students (two graduated summa cum laude, the third magna cum laude) prepared an in depth analysis of Lucent Technologies with a new DCF valuation model. The model was more sophisticated than what I had learned at graduate school in my day. I used my simpler model to come up with a value of about $17 a share. Their model came in with a similar valuation.

    At that time Lucent was trading in the high teens. An investment newsletter I liked, Drip Investor, Your Guide to Buying Stocks Without a Broker (www.dripinvestor.com) had originally been very positive about Lucent, noting that it owned Bell Labs. (Bells Labs had been the R&D center of AT&T with hundreds of leading edge technology patents.) I also noticed that insiders were now buying the stock.

    Furthermore a friend of mine who was the lead engineer for large telecommunication projects in the Middle East was very positive about the company. Its products were good. He knew some senior engineers at Lucent who were purchasing the stock. It would go up because Lucent had won some gigantic contracts in the Middle East, and the share price did not reflect that yet. I had insider information, hearsay, admittedly, but credible nonetheless.

    I made my decision. I bought cash secured puts on Lucent at $15.00 a share. That would be the floor. Lucent might dip below that, but would have to bounce back. As I had lost a substantial amount of money on paper, I purchased enough puts to recover these losses. In other words, I made a major move.

    Lucent continued inexorably down, down, down, winding up at less than $1.00 a share before it started climbing back to a couple of dollars a share. I had lost the entire value of the inherited shares, and, as if that were not enough, had thrown good money after bad in a foolish attempt to recover the losses.

Lesson

    If you worked hard to earn your money, devote a corresponding amount of energy and time into investing it. For starters, always have an exit strategy on any stock you buy. Put stops on it. You can always ratchet the stops up if the market is climbing rapidly. Alternatively buy out-of-the-money LEAP puts as catastrophe insurance to protect yourself on the downside.

    You want a broker who understands the use of options to protect your portfolio, as opposed to one who thinks of options only in terms of speculation. The bible of options trading, Options as a Strategic Investment by Lawrence G. McMillan, Simon & Schuster, 1993 should be on his desk right next to his dictionary. If you are using a full service broker with high transaction fees, he should have told you how to minimize those fees by purchasing stock with cash secured puts, the same way the pension funds and insurance companies do.

    What? He did not tell you about that?

Lesson learned

    William Buffett¹ is right: do not invest in something you do not understand.

    My mother once met the then little known William Buffett in New York City. He was looking for investors for his young firm, Berkshire Hathaway, then trading at about $50 a share. She liked him and promised to invest a recently inherited $50,000 with him for one thousand shares. Everyone else thought that would be crazy. Family, advisors and friends all foretold disaster -- putting all your eggs into an unknown basket? 

    So at the very last minute, my mother got cold feet and backed out. Instead she followed the professionals´advice and invested the inheritance in a prudent, diversified portfolio of Fortune 500 companies with more reasonably priced shares. Family, friends and advisors breathed a collective sigh of relief that sanity and common sense had prevailed. Over the long term, the portfolio wound up losing money.

    Recalling my mother’s missed opportunity (a much repeated family tale of woe), I took a second long, hard look at Berkshire Hathaway in 1994, when it was $20,000 a share. I decided it was too expensive. I invested instead in a prudent, diversified portfolio of Fortune 500 companies. Over the long term, the portfolio has wound up losing money. In April 2011 Berkshire Hathaway shares were trading around $123,500 each.

Aftermath

    UBS - what could be safer than one of the big three Swiss banks? I started investing in a retirement program funded with bank stock. I had been able to start my retirement fund at preferential terms in the 1970s due to my having a “resident account,” i.e. my living in Zurich at the time. In 1998 Swiss Bank Corporation merged with Swiss Union Bank to become UBS. A couple of years later I happily noted the stock had reached $65 a share.

    In recent years it has traded between $19 and $7 – a quarter century of faithful contributions just pulverized, so much for risk free, stable Swiss bank stocks.

1 Warren Edward Buffett (born 1930) is one of the most successful investors in history, the primary shareholder and CEO of Berkshire Hathaway. His first business venture was in 1945, when as a freshman at high school he and a friend spent $25 to purchase a used pinball machine, which they placed in a barbershop. Within months, they owned three machines in different locations.

    Buffett first enrolled at The Wharton School, University of Pennsylvania, (1947–49). In 1950, he transferred to the University of Nebraska where he received a B.S. in Economics. Buffett then enrolled at Columbia Business School after learning that Benjamin Graham, (the renowned securities analyst and author of The Intelligent Investor) taught there. He then received a M.S. in Economics from Columbia University in 1951.

    Despite his immense wealth, he is frugal. In 1957 he purchased for $31,500 a five-bedroom stucco house, in which he still lives, in Omaha, Nebraska. In 1962, Buffett became a millionaire through his investment partnerships. In 1970, as chairman of Berkshire Hathaway, Buffett began writing his now famous annual letters to shareholders.

    In 1979, Buffett's net worth reached $620 million. However, he lived solely on his salary of $50,000 per year. In 2006 Buffett announced that he gradually would give away 85% of his Berkshire holdings to five foundations in annual gifts of stock. The largest contribution would go to the Bill and Melinda Gates Foundation. (He has long been a personal friend of Bill Gates.) In 2009 Buffett was ranked as the second richest man in the United States (after Bill Gates) with a net worth of $40 billion, after having given billions to charity.