This is a little light on ideas, but happens to be our favorite column in the history of this site. This originally ran on January 26, 2008.
Charlie was the consumate bully. One of the older kids in the neighborhood, and also the paperboy, he had a bad reputation and it was well earned. The event that occurred on one snowy day in our small quiet town in central NJ some 30 years ago can today be used as a metaphor for an important investment lesson.
We'd spent much of the day building a huge snow fort--my brother and I, Jimmy and Jon, brothers who lived across from us, and a few other assorted neighborhood kids. We could all fit inside this circular structure, but the walls were so high that we could not see out, save for a "window" or two built into the wall. Definitely the best snow fort we'd ever built.
But we soon realized that our snow structure's hours of existence were limited. Not because of the sun, but because of something much more menacing: Charlie. We realized that he was due to make his afternoon newspaper deliveries, and as soon as he saw our fort, he would very likely destroy it. At 15 or 16, Charlie was a big kid, and could severely damage our fort with one flying leap.
We thought quickly. If Charlie was going to take down our fort, he was going to do so at his own peril. We quickly loaded that snow fort with everything we could find--rakes, shovels, other garden implements standing upright, even a full size garden tractor. He might take down the fort that we spent all day building, but that bully was not going to walk away unscathed.
We hid in the bushes, and along came Charlie. He saw our snow fort, but could not see what was contained within. He stopped, he sprinted, he jumped, and landed, destroying our fort. How proud he must have been as he hit that wall of snow--until a split second later when he landed on a tractor, several garden implements, and half the contents of Jimmy and Jon's garage. Charlie got a big, painful surprise that snowy afternoon. What appeared to be a harmless, ultra white snow fort, was actually much more. It's contents could not be seen from the outside; hidden within it's walls were dangerous, unseen risks.
That day, Charlie the bully cried like a baby. I don't remember seeing him all that much after that. He didn't suffer any permanent damage, and in hindsight, I'm glad he was not injured. We all (I hope) learned important lessons that day.
Hopefully the investment lesson is clear. During those times of financial crisis, when companies are beaten down, we as investors have the propensity to be fooled by the "It's down 50%, it can't go any lower" sentiment. That's the time to be aware of what might really be contained within a given company's situation. Is their peril lurking behind snowy white walls? Is it really worth the risk?
Charlie, if you are out there, I'd bet you wouldn't go near the Radians (RDN), MBIA's (MBI), or other such companies that have been trounced, yet may still conceal the unexpected. There may ultimately be reward, but how much risk are you willing to take?
*The author does not have positions in any of the companies mentioned. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.