Too Good to Be True?
We have all heard the phrase, "if it seems too good to be true, it probably is." Well, let's see if the old mantra held true for investors who owned shares of the company that we highlight below.
Following its initial public offering in late 1985, this NYSE-listed firm achieved steady growth in earnings and dividends, and the shares delivered a hefty annualized return of 25% from January 1986 to December 1999, crushing the S&P 500 Index by nearly 7% per year.
Even during the subsequent bear market of the early 2000s, the company continued to soar: its total return for the three-year period ending December 2002 was a whopping 44% as compared to -38% for the S&P 500 Index.
And when the market recovered, it performed even better, beating the S&P 500 by a healthy margin in each year from 2003 to 2006. Over the 20-year period ending December 2006, the firm's shares outpaced those of Warren Buffet's Berkshire Hathaway by 4.5% a year.
Not a bad run.
This company had a well-deserved reputation for grinding out steady profits in a competitive business. Over its 85-year history, the company 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.
Sounds like a sure-fire winner most investors would be delighted to have at the cornerstone of their portfolio, right? Let's ask any one of the thousands of Bear Stearns employees who saw their shares collapse two months ago as the firm narrowly avoided a bankruptcy filing and agreed to sell itself to JP Morgan Chase for $2 per share, down a whopping 93% from its closing price the previous trading day.
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 at night, 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 did not 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 late March, the Fed stepped in to support JP Morgan’s offer for Bear Stearns by agreeing to fund $30 million of Bear Stearns' assets that would be difficult to sell quickly. The stock rebounded slightly, (only to the delight of those shareholders who bought the stock at the company’s closing price of $4.81 on March 17, 2008, the day after the announcement), but even if the final liquidating value is equal to Bear Stearns closing price on April 30, 2008, 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 1/3 of the shares are owned by Bear Stearns employees, many of whom now face the prospect of losing not only their jobs, but a substantial portion of their investment portfolios.
Once again, we are faced with another grim example of the high risk of allocating a substantial portion of a client's portfolio to a single type of investment, the importance of asset allocation and diversification and the unimaginable effect that the collapse of this Wall Street giant had (and will have) on the financial futures of many of its shareholders and employees.
Sources
Bary, Andrew. "How Sweet It Is." Barron's, August 2, 2004.
Bear Stearns Companies Inc. Press release, March 10, 2008.
Bryan-Low, Cassell, and Kate Kelly. "A Stake through the Heart." Wall Street Journal, March 17, 2008.
Yahoo! Inc. Yahoo! Finance. http://finance.yahoo.com, accessed April 30, 2008.
