Post-Mortem Analysis: Your Worst Stocks Can Make You Money!

Adem is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Why is it so darned hard for us to admit when we’re wrong? It’s true of work, relationships; in investing, you can multiply it by a thousand. Perhaps that’s why CNBC host Jim Cramer, who actually know a ton, feels obligated to change positions on a stock six times a year (approximately, depending on performance).

I don’t blame him. In finance, the “experts” are expected to always be right. What lessons is this teaching us? Truthfully, you’ll learn (and earn) more by analyzing your losers than your winners. I’ll walk you through this practice, and we’ll use one of my losers as a case study.

Step 1: Admission (A.K.A. Dr. Phil “Get Real” time)

In 2010, I (gasp) bought shares in First Niagara Financial Group (NASDAQ: FNFG). In fact, I still own some today.

Step 2: Identify Why You’re Disappointed in Your Investment

My beef with FNFG started when it announced plans to acquire 195 New York and Connecticut HSBC (NYSE: HBC) branches on July 31, 2011.  Prior, I’d actually been encouraged by the acquisitions (we’ll get there) of FNFG hoping it was becoming a “baby Bank of America”.

The move worried me, largely because First Niagara planned to raise the needed funds by selling stock. Diluting shareholders is never good, but coupled with the fact that banks were selling off at the time, and First Niagara had just recently closed a huge acquisition (NewAlliance Bank) the move reeked of greed, desperation or both.

In short, disaster followed. Bank shares continued their “debt ceiling” slide, and FNFG couldn’t sell shares at the planed price (around $11). Their offering sold at just $8.50; then, they also sold $350 million in preferred shares with a ridiculously high coupon of 8.625%. Then, as if dilution and debt weren’t bad enough, FNFG slashed its quarterly dividend 50% to fund the move!

Step 3: Identify the Reason(s) You Originally Bought Shares

These are the reasons FNFG looked like a buy through my “rose-colored glasses” in 2010.

Dividend: In 2010 FNFG had a great dividend of $0.64, for a 5.5% yield.

Valuation: FNFG traded at low valuation on both price to book and earnings, compared to its peers, and analysts expected EPS growth of 10% going forward.

Expansion: Ironically, the acquisitions by FNFG were something that drew me in in 2010 (pre-HSBC). I’d heard endlessly on CNBC that after the S&L crisis of the 80’s, quality banks gobbled up the assets of distressed ones and became “players.” With the 2009 purchase of 57 National City branches and Harleysville -- and of course, in August 2010 (just before I bought), the “big hitter” purchase of NewAlliance Bank -- FNFG was becoming my “baby BAC.” Or s I thought. Many investors agreed; after all, the purchase of NewAlliance doubled the bank's size, making it the 23rd-largest U.S. bank.

Step 4: Identify Your Mistakes. Be Honest.

My mistakes on FNFG are clear in hindsight, and humorously line up very symmetrically with the reasons I bought!

Dividend: This is the easiest lesson we can learn from my mistake: Dividends are great, but they must be sustainable. FNFG earned $0.87 a share in 2010, and paid a dividend of $0.64, with a wildly unsustainable pay-out ratio of 75%. Yes, I got burned, but let’s learn from my mistake: Stick to companies with payout ratios below 50% (no exceptions).

Valuation: You just can’t rely on traditional valuations such as price to book with financials, I learned this rule in 2008, but ignored it with FNFG. Unfortunately, we’ve learned you can’t trust the stated value of assets on banks' “books,” so P/B is irrelevant today. Measure return on equity or assets when judging any company's performance, especially with banks. You want to know what they earn vs. what they spend. FNFG’s ROE had slid year over year. I wanted to buy, so I looked away.

Expansion, History and Management: It turns out that all of those “experts” discussing the M&A activities after the S&L crisis were dead wrong. History doesn’t determine the future, and this “low rate” era of Bernanke was not the same on “thrift banks” as era’s past. Further while companies like Wells Fargo went on acquisition binges in the late 80’s (Barclays, sectional BAC), they had a seasoned and savvy management team with a record of successful acquisitions since 1960. The CEO at FNFG (John Koelmel) started in just 2006 and had essentially been on a nonstop acquisition spree since day one. I should’ve stopped to ask why.

Don’t Wince, Learn

To learn, we must guard ourselves from confirmation bias and the voices of consensus. I’ve shown you how a “post-mortem” analysis is conducted, but can you see what it revealed? Like a symphony of horror, all of the moving red flags worked in concert!

  • The unsustainable dividend was necessary to retain investors, keeping the stock price high.
  • A high stock price was needed so they could raise substantial capital by selling new shares.
  • They needed to raise capital to make reckless acquisitions and grow EPS, which brings us to the post-mortem lesson learned...

They Couldn’t Grow Earnings Organically!

In fact, in spite of surging revenues, FNFG’s EPS is less than it was in 2010, thanks to all our new shareholders!

Learn from my post-mortem: Stick to companies that grow organically, with sustainable business practices. Next, perform your own post-mortem. What’s your worst stock? The comment box is waiting!


Adem Tahiri owns shares of First Niagra Financial Group. As of this writing, he had no plans to change this position. The Motley Fool owns shares of Bank of America and Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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