Well I finally got to 50. The anticipation has been building up for weeks now and everyone has been waiting for this post… yeah right.
I wanted to cover something meaningful at such a milestone post number. I figured, what better way to do that than by replaying my biggest money management and investing mistakes since I started investing in 2013, and to highlight the real risks that exist with investing and with not understanding the risks associated with managing your money? This is really going to be painful going back into my trading account history and reliving these “wise” experiences on my part.
#1 Oil is Everything
I started investing and learning about investing in the early part of 2013. I didn’t know what I was doing, and fell for the very common behavioral finance pitfall of believing that past stock performance is indicative of future stock performance. Specifically, I was seeing that the oil and gas sector, which primarily drives the performance of the Toronto Stock Exchange index, was on a steady climb for a number of consecutive years. I capture this through a chart of ZJO which is a Canadian ETF comprised of oil and gas companies:
Figure 1: ZJO Chart #1
So in 2013, and throughout 2014, it seemed obvious to just buy oil and gas companies on the TSX, because I was guaranteed a positive return over time. By mid 2014, about 90% of my portfolio consisted of oil and gas companies on the TSX. These included companies like Suncor (SU), Enbridge (ENB), Keyera (KEY), Husky (HSE), Tourmaline Oil (TOU), Inter Pipeline (IPL), TransCanada (TRP), and Encana (ECA). Even admitting that I used to own all of these at one time almost makes me want to throw up.
To add insult to injury, the remainder of my portfolio consisted of Canadian financial sector companies, which had also seen a gradual increase in price over the past few years. This is no surprise since the TSX is driven by oil and gas and financial sector companies (the two almost go hand in hand… better oil and gas sector, better economy, more people are buying houses, and bank lending increases due to this and increased corporate leveraging). So mid 2014, my portfolio consisted of a bunch of Gap T-shirts that I severely overpaid for, and the one company back from 2014 that I still own today, Constellation Software (CSU).
Then, the Canadian economy saw a downturn leading into 2015 driven by a sharp decline in the oil and gas sector, which can be seen from the ZJO chart:
Figure 2: ZJO Chart #2
My portfolio got crushed, and what I once thought was an obvious investing strategy turned out to be one of the first big lessons I learned about investing.
Lessons learned?
Number one… always keep your portfolio diversified across sectors no matter how good something appears to be. Past performance only reflects things that companies have done in the past or the past healthiness of a particular sector, not what will happen. Behavioral finance captures this fallacy as one of the primary mistakes that beginner investors do all the time... buying something because it’s going up. That is looking in the rear-view mirror, and repetition of this type of behavior will eventually make you blind to the brick wall you’re about to drive into.
Just remember, there is no trick or easy way to predict the movement of markets. Oil, or any other sector, is not “everything” or the be-all and end-all. Over the long term, companies grow, economies grow, and markets grow. Stay invested in well managed, profitable, and growing businesses, and your portfolio returns will speak for themselves.
#2 S-C what?
Good old SCO. This is a double leveraged inverse ETF that tracks the price of WTI crude oil. In 2015, oil was experiencing a sharp downtown in price, from previously trading at over $100/bbl back in the middle part of 2014, to eventually trading in the mid 40s at the end of 2014. I figured there was no way that oil long term could trade down at these discounted levels, or perhaps even lower. And because this was also the time I was experimenting and learning about options (aka I didn’t fully understand them yet), I decided that double leverage inverse exposure wasn’t enough, so why not trade options on this bad boy?
With a bullish sentiment on oil in mind over the 2015 year, I decided to purchase put options on SCO. Put options on a double leveraged inverse ETF on oil… sound confusing? In other words, if the price of oil increases, this ETF would go down twice that percentage amount, which would make my put options quite profitable. I purchased put options with expiration at the end of the 2015 year to give me time in case oil stayed stagnant for a while. Also, I figured this was a clever trade since leveraged instruments decay over time, and in the case of put options on SCO, the natural decay would work in my favor (imagine $100 dollars going up and down 1% every day over a long period of time… what happens to the $100?). I also purchased an option position that was equal to about 20% of my entire portfolio value… what the hell was I doing?
At first, I thought I was a genius. I remember drinking Somersby Ciders on a rooftop patio in Melbourne with my brother, and watching oil rise over $50/bbl, and my SCO position beginning to balloon.
Figure 3: WTI Crude Oil Price ($/bbl)
Figure 4: SCO Chart #1
Up over 100% on my SCO puts by February, I decided to dump half of my option position (thank god I was somewhat logical). Yet, I still held about 10% of my entire portfolio in these put options. I eventually returned back home and back to reality, and figured I’d continue to hold my position throughout 2015. I figured there is no way the world would sufficiently operate at sub 40 oil prices long term. While that’s probably true, short term was a different story and oil quickly plummeted to $25/bbl, and SCO spiked, not once, but twice, before the end of the 2015 year, right when my options expired.
Figure 5: WTI Crude Oil Price ($/bbl)
Figure 6: SCO Chart #2
I was toast. My options were far out of the money at this point and essentially 10% of my portfolio value was now worthless. Although I was right in thinking that sub 40 dollar oil wasn’t sustainable long term, there’s no way to time what “short term” meant and how long that would last for, especially when dealing with options that have an expiration.
Lessons Learned?
Well, first off, only trade options if you fully understand them and how they work. A lot of people see the potential of making a lot of money fast, but never consider the fact that you can also lose a lot of money just as fast. Secondly, never commit to a large percentage of your overall portfolio to something risky like options. When it comes to options, these are purely trading tools to either mitigate risk, or to take a gamble and play a directional movement of a stock. These are short term instruments used to leverage one’s exposure to a particular stock. Only use an amount of money you are comfortable losing when buying options. These are very risky instruments that not only decay over time (time value goes to zero), but are wildly volatile because of the inherent leverage in them (each contract gives exposure to 100 shares). Lastly, because of the volatility of option premiums, if you are going long options, don’t stick around for too long in them because the time value decay will eat you alive. If you see a significant gain in your position, take it and don’t be greedy.
Better yet, just don’t buy options and ignore them altogether. You’ll be better off return wise and mentally! I lost a lot of sleep over this with tremendous stress tracking the stupid ETF day after day... not worth it, trust me.
#3 Best In Public Markets Bro
Unlike most donair shops in Edmonton, I don’t claim to be the best in town, and in 2015, I for sure wasn’t fitting the bill of being the best in public markets. Back in 2015, I came across a company that fundamentally looked very strong, was growing rapidly, was projecting sustained rapid growth, and showed reasonable valuations give its growth projects. This company was Concordia Health Care (now called Advanz Pharma Corp. on the TSX). This investment combines the mistakes from #1 and #2 into one giant #3 mistake!
This company looked amazing to me. I began purchasing the stock in early 2015 and continued dollar cost averaging in throughout the year. Based on analyst forecasts and current quarterly earnings reports in 2014, the company was trading at an earnings multiple just below its historical mean and market index mean based on forward 2015 earnings, while maintaining a return on equity of greater than 20% for the last 8 quarters, and a year over year earnings growth exceeding 30% for the last several years. The company continued to engage in acquiring pharmaceutical companies, with the biggest acquisition occurring in 2015 through the purchase of Amdipharm Mercury Limited (AMCO) for $3.3B. I kept buying on the uptrend throughout 2015 and I eventually owned an amount of CXR equivalent to 25% of my entire portfolio (wow... talk about diversification).
Figure 7: CXR Chart Jan 2014 - September 2015
I was comfortable having so much of my portfolio in this company because I thought it was the greatest thing on Earth (or at least on the TSX). Then a series of events happened around the fall of 2015 that started reversing this risk-free uptrend that the stock had seen for years.
First off, the big AMCO acquisition roughly doubled Concordia’s current market capitalization, and required significant levels of debt and equity financing which included various forms of bank facilities, senior notes, and issuance of common shares. Shortly after the acquisition, questions began circulating amongst analysts and institutions tracking the stock about Concordia’s ability to afford its cost of capital at its current debt levels, and whether or not its current level of cash flow was sustainable to meet current debt obligations and covenants going forward.
Around the same time as the AMCO acquisition, Concordia reported its Q3 2015 earnings which slightly missed analyst’s expectations. At the same time, the Valeant Pharmaceutical scandal had begun to unravel, and questions around unfair drug pricing in the pharmaceutical industry began surfacing. Favored US presidential candidate Hilary Clinton had made several comments about the need for strict drug pricing regulation which she would surely implement under her future presidency once she got elected into office.
The stock began to tank, and my once beloved invincible stock began to deteriorate. So what did I do? I bought more and lowered my dollar cost average into the stock.
In the coming months leading into 2016, news continued to come out around Concordia’s inability to afford its cost of capital, its inefficient capital structure, as well as criticism around Concordia’s unethical accounting revenue recognition tactics to misstate earnings higher than reality to make the company look undervalued. The stock price continued lower through 2016 with the constant negative downward pressure on the pharmaceutical sector from political leaders and iconic short sellers. I eventually sold the last of my position for $21 per share in Q1 2016. My dollar cost average price for CXR was around $63 per share. The resignation of the CEO followed and allegations and lawsuits arose around Concordia’s accounting practices and whether the best interest of shareholders were upheld through Concordia’s M&A activity over the last several years.
Lessons learned?
I purposely went into plenty of detail around this stock and its eventual demise for a reason. No matter how good something looks, no matter how bulletproof it may seem, always stay diversified in your investing portfolio and never be overweight in any one particular stock name. Doing so only adds unnecessary risk to your portfolio. I never blame myself for investing in CXR because the financials that were publicly available told a promising story about a successful growing company. How would I know that some of these metrics were exaggerated and the company was engaged in accounting malpractices? Well I couldn’t know, and it is the risk of black swan events like this that are reasons as to why you need to remain diversified in your portfolio. I don’t blame myself for buying CXR, but I do blame myself for buying so much of it, and not having an open mind as to what was really going on with the company when the bad news surfaced. At one point, it represented almost 25% of my entire account. Realizing over a 65% loss in my CXR position really hurt my account, and I am still making up for some of those losses today. This was my largest investing mistake to date, and it is a big driver in how I invest and allocate risk within my portfolio today. When ignorant investors are loading up their portfolios and becoming severely overweight in pie in the sky companies (usually not profitable) like cannabis stocks, companies that have “blockchain” in their name, crypto currencies, or any “hot fad” stock, this is just a disaster waiting to happen. Behaviours like this fuel my motivation to continue to put out posts about responsible money management and thoughtful investing, even if only a handful of people read it and absorb the message.
To hammer the nail once more... From its high of $110.60/share on September 5, 2014, Concordia Health Care, listed under the name Advanz Pharma now, trades today for less than $1/share. In addition to the name change to save face, the company approved a 1:300 reverse stock split in 2018.
Any company that has a Z replacing a plural S in its name is surely to be garbage.
Well there you have it. My three biggest investing mistakes to date. Instant replay is widely used in professional sports to replay events, but unfortunately instant replay isn’t available in real life decision making. I hope these lessons, along with the last 49 lessons posted since January 2017, have provided value and insight into responsible money management and investing of your money. I hope to continue to achieve this goal in the next 50 lesson posts.
Stay tuned and let’s continue to make sense of making cents and dollars.