ENRON COLLAPSE HAS LESSONS FOR INVESTORS
By DOLORES KONG
12/16/2001
The Boston Globe
The largest bankruptcy protection case in US history,
filed two weeks ago by energy-trading firm Enron,
holds painful lessons for everyone, from the big money
manager to the small investor, from the institutional
bondholder to the rank-and-file employee.
The meltdown began in earnest last month when the
once-mighty Fortune 500 company told US regulators it
would be restating financial statements dating to 1997
to reflect a "$1.2 billion reduction to shareholders'
equity," or the difference between assets and
liabilities.
Then an attempt to enter into a merger with
much-smaller rival Dynegy Inc. fell apart. Thousands
of employees have been laid off. And federal
investigations and multiple class-action lawsuits have
been launched.
Not so long ago, the Houston multinational was a Wall
Street wonder, hailed in business and personal finance
publications as an innovative force in a deregulated
energy industry, with its stock price flying high to
about $90.
Just last year, Fortune magazine featured it as one of
10 stocks to buy for the long haul in a "Retire Rich"
cover story. Throughout 2001, Money magazine listed
Enron on its "Money 30 Index," made up of "blue-chip
growth stocks at the forefront of today's economy."
Now, Enron trades for pennies a share.
Lesson 1: Don't buy a stock just because you read
about it in a magazine, or otherwise got a hot tip
about it.
By the time a company is widely recommended, it's
probably already well-discovered and a lot of the big
money has been made.
Reading about a company or otherwise hearing a tip
about a stock should just be the starting point for
your own research. If you want to own individual
stocks, you've got to do your homework, understand the
risks, and know the basics of portfolio management,
such as diversification.
Lesson 2: You can't just rely on Wall Street analysts.
As recently as two months ago, 14 stock analysts had a
"strong buy" recommendation on Enron, three had a
"buy," and only one had a "hold" (which is widely
interpreted as "sell"), according to Quicken.com and
Zacks.com.
If you're going to consider Wall Street research in
doing your homework, you should be aware that there's
rarely ever an outright "sell" recommendation, partly
because many of the same firms that provide investment
research also make money off underwriting company
stock offerings. Analysts may avoid saying "sell" on a
company because they don't want to jeopardize the
possibility of their employer's underwriting that
company's future stock offerings.
Lesson 3: Don't think you're immune from Enron because
you only own mutual funds.
Swept up in the onetime frenzy for Enron were managers
from such mutual fund families as AIM, Alliance,
Fidelity, Galaxy, and Janus.
Some funds in those families had Enron among their 25
top holdings as recently as September, according to
Morningstar.com. The June issue of Money magazine
listed Janus fund as having Enron among its 10 top
holdings as of April.
For individual investors, a saving grace of most
mutual funds is the built-in diversification that
comes from a fund's ownership of dozens if not
hundreds of stocks. So even if a fund owned Enron
among its top holdings, many investors were probably
buffered from the worst of the meltdown.
But there are some fund investors who need to be
particularly wary of Enron's impact on their holdings:
those who own sector funds specializing in energy. A
sector fund goes contrary to the notion of
diversification, and can be riskier.
Lesson 4: Don't load up on company stock.
Whether you've worked at Enron, Polaroid, or any other
company that's recently filed for bankruptcy
protection or gone out of business, this may be the
most painful lesson of all.
In some situations, an employee has no choice but to
own some company stock, if that's the only way the
employer provides matching 401(k) contributions.
But amazingly, some Enron employees apparently went
out and bought additional shares of company stock in
their retirement plan, beyond the 50 percent match in
Enron stock that the company provided to most 401(k)
participants, through what's called a self-directed
brokerage account, according to my review of filings
with the Securities and Exchange Commission.
Such self-directed brokerage accounts, a relatively
new development in some 401(k)s, have been touted as a
way to allow employees to invest in the whole universe
of stocks and mutual funds, not just the limited menu
that's typical in traditional 401(k) plans. But
whoever bought the additional shares through those
accounts would have seen the value shrink. According
to SEC filings, the Enron stock in the self-directed
brokerage accounts totaled more than $100,000 at the
end of 2000. At today's price, those shares are worth
about $1,000.
For any employee owning a load of company stock within
a 401(k), remember this: There's a federal law that
limits a company pension fund to having no more than
10 percent of its assets in company stock. That's
probably a good reason for you to try to do the same
with your own retirement savings, for the sake of
diversification.