Big bets on single stocks can lead to huge gains — or financial ruin.
With the benefit of hindsight, the stock market makes perfect sense. Of course, the rise of the Internet in the 1990s would be an economic boon. Of course, credit markets were horribly overextended in 2008, resulting in a massive correction.
The same holds true at a micro level as well. In hindsight, the overwhelming challenges of companies that have gone belly up seem obvious. But at the time, the naive outlooks and ultimately disastrous business plans made sense to management and to investors. Although more inspired leadership may have saved some of these companies, incompetency alone isn’t to blame. Sometimes the innovations and macroeconomic events that disrupt companies or even entire industries seem to happen overnight.
Below is a look back at insights from eight companies’ SEC Form 10-K annual reports that seemed to show that they were racing ahead. Little did they know that they were actually about to fall off a cliff.
Borders Group: Superstore or Bust!
In early 2005, Borders was blissfully unaware of the looming threat posed by Amazon. In the annual report that year, the company acknowledged struggles but sounded confident in its plan to double down on brick-and-mortar bookstores.
The Company’s growth plan is primarily based on its ability to open and run new superstores profitably. In 2004, the Company completed major remodels of 33 existing domestic superstores and opened 19 new domestic superstores as part of an ambitious expansion and remodel program.
In hindsight, the notion that Borders could be saved by building more superstores is comical. But that’s precisely what investors bet on at the time. In 2007, the first Kindle hit the market. By 2010, Amazon’s e-book sales surpassed paperback sales for the first time. In February 2011, Borders filed for bankruptcy.
Motorola: More RAZR!
Once upon a time, Motorola was on top of the tech world. In the 2005 annual report, the company celebrated the massive success of its RAZR phone, which had sold more than 23 million units at the time.
We’ll continue to build on the MOTORAZR’s popularity with ultra-thin devices, such as the QWERTY keyboard, which was launched in 2006.
A few months earlier, Motorola CEO Edward Zander was euphoric after Motorola smashed earnings expectations on the strength of strong RAZR sales. In response to an analyst question on the future of the company, Zander offered a simple vision.
What’s next? More RAZR.
In June 2007, Apple launched the first generation of the iPhone. Five months later, Zander announced his resignation. Google acquired Motorola Mobility in 2011, paying $12.5 billion in a transaction primarily to acquire the company’s portfolio of patents.
Kodak: What Technology?
A few excerpts from the 2005 annual report highlight how Kodak failed to grasp how digital photography would change the way consumers and businesses take and share photos and videos.
Some aspects of the consumer imaging industry remain unchanged as technology advances. People continue to pursue simple solutions that allow them to take, share, and monitor photographs of themselves and their lives. Kodak is committed to developing new capabilities while remaining true to the company’s founding principle of “you push the button, we do the rest.”
While acknowledging that the company faced challenges, management also pounded its chest over what it viewed as some major accomplishments. Specifically, the report celebrated that Kodak was:
#1 worldwide in snapshot printers, competing against the specialized printer companies.
#1 in retail photo kiosks, with nearly 75,000 installed worldwide — far ahead of our nearest competitor.
#1 in online services with the Kodak EasyShare Gallery, which today has more than 30 million registered members.
Although in the middle of a storm, management told investors of brighter days ahead.
In keeping with our plan, we expect all of Kodak’s companies to be leaders in their respective industries by 2008, with attractive margins and significant cash flow… Kodak is in the midst of a truly exciting era.
These celebrations and predictions seemed appropriate at the time. In hindsight, they are comical. Kodak spent the next several years selling off businesses to raise capital. In 2010 the company was booted from the S&P 500. In 2011 shares fell more than 80 percent and hit an all-time low of $0.54 per share. In early 2012, the company filed for bankruptcy protection.
Krispy Kreme: Doughnuts Forever!
In 2003, Krispy Kreme was flying high. The stock had gained more than 200 percent since its IPO in 2000, and new stores were opening on a weekly basis. In the 2003 annual report, management saw even better days ahead.
Doughnut sales are projected to continue to rise due to several factors, including the rise in two-income households and the subsequent move toward foods eaten outside the home, increased snack food consumption, and increased doughnut purchases from in-store bakeries.
The future seemed as bright as the signature “Hot Doughnuts Now” sign, but some unforeseen challenges awaited. The following words were never mentioned in the 2003 annual report but would weigh heavily on KKD shares in the following months:
Krispy Kreme stock was hammered by the low-carb craze that swept the country and still trades below prices hit in September 2000.
New York Times: Hooray, Internet!
In 2003, the newspaper industry was about to undergo a drastic change that would result in numerous bankruptcies and consolidations. However, the New York Times’ 2003 annual report hardly acknowledged the role of the Web in the news industry. In listing its primary competition, the Internet barely beat out “other media.”
The Times also competes with magazines, television, direct mail, radio, the Internet, and other media.
If anything, the Times was thinking of the Web primarily as a source of new delivery customers.
The reach of the Web sites is instrumental in creating a substantial stream of newspaper subscription orders each year.
At the time, management was much more focused on managing the costs of newsprint (57 mentions in the report) than the pesky Internet (10 mentions).
One of the Company’s key management priorities is anticipating the level of advertising volume and newsprint prices. At the same time, it manages its businesses to maximize operating profit during expanding and contracting economic cycles.
Beginning in 2004, NYT stock collapsed as intense Web competition eroded the subscriber and advertiser bases. The stock remains about 60 percent below its 2003 price.
General Motors: Oops!
The automotive industry was rocked in 2005 when the unthinkable occurred: gas prices increased. The companies that had cashed in for years on strong sales of SUVs and trucks were suddenly scrambling to stay afloat.
Within a few months, carmakers saw sales collapse, and their ongoing existence called into question. Excerpts from GM’s 2004 and 2005 annual reports highlight just how quickly things changed in Detroit during the year.
On the Company’s Outlook:
On the Company’s Goals:
On Health Care Costs:
On Fuel Efficient Vehicles:
On Marketing Plans:
CEO Rick Waggoner struck a positive tone in closing his letter to shareholders in 2005.
I am confident that we’ll emerge from these challenging times stronger, smarter, and a better global competitor.
Unfortunately for GM, the challenging times were far from over. In its bankruptcy filing four years later, GM noted $82 billion in assets and $173 billion in debt.
Blockbuster: DVD Dynasty!
In hindsight, buying Netflix for $50 million in 2000 probably would have been a wise move for Blockbuster. But the company was bullish on a long future for the DVD and excited about its positioning within that market.
In the 2005 annual report, management saw a growing DVD business.
[W]e believe that the DVD format will drive continued growth in the retail home video industry due to the increasing popularity of in-home theater systems and related enhanced viewing and sound capabilities, and the anticipated launch of high-definition DVD. We also believe that there are continued opportunities in the consumer market for used DVDs.
Four years later, the focus was still on DVDs. From the 2009 annual report:
Subscribers to our by-mail service can choose DVDs online and have them delivered to them for free through US mail. If a subscriber has finished watching the DVD, they can return it to a participating BLOCKBUSTER store or send it back using the postage-paid envelope that came with it.
Blockbuster filed for bankruptcy in 2010 and closed the last 300 of its remaining stores in 2014.
Lehman Brothers: More Credit Sales!
A few months before it became one of the largest bankruptcies in U.S. history, Lehman Brothers were optimistic about the future. The following comes from the 2007 annual report.
We greatly appreciate the continued support of our clients and shareholders. We have never had a more diversified set of businesses or a stronger base of talent. As we enter 2008, we are proud of how far we have come and excited about the opportunities ahead.
Amid the recession and only months before their collapse, Lehman Brothers touted their risk management capabilities.
Amid unprecedented credit market dislocation and weakening global growth, clients increased the amount of business they do with us. One measure of how we delivered for our clients, Fixed Income sales credit volume, rose 40% in 2007. More than ever, we believe our risk management capabilities, strategic advice, and support across cycles have been of significant value to our clients and partners.
Less than one year later, Lehman Brothers’ stock collapsed, and the company filed for bankruptcy.
Diversify, Diversify, Diversify
Much of the commentary around ETFs in recent years has focused on the nuances of the structure and the precise differences between various methodologies. Often overlooked is perhaps the most meaningful benefit of using ETFs in a portfolio — efficient diversification across a broad basket of securities.
Investors tend to underestimate the volatility of individual stocks. A big bet on a single stock seems brilliant when the company exhibits Apple-like growth. When the company implodes, however, investors who placed big bets can experience financial ruin. History is full of events that management and investors never saw coming; seemingly strong, unstoppable companies can be decimated virtually overnight, wiping out portfolios in the process.