Learn from Bill Ackman (Trades, Portfolio)’s Mistakes
As of Friday’s close, July 15, 2016, Bill Ackman’s Pershing Square Holdings (PSH.AS, PSHZF) is down 41.3% since its IPO in October of 2014. Throughout the same timeframe, the S&P 500 is up 7.09%. Ackman has been a great portfolio manager and generated large gains of about 20% per year leading up to his IPO and gained 40.4% in 2014. Although he has experienced great success in the past, recently there are aspects of his investing that remind me of the most common mistakes that I have seen from amateur investors over my years as a stock broker. Let’s take a look at some of these characteristics that have helped lead to the large losses and use them as a learning experience.
Lack of a Trading/Investing System That Can Be Written Down
Successful traders and investors have a system that has been successfully tested and can write down when to buy and sell a stock. Systems can range from day trading, value investing, CAN SLIM, Warren Buffett’s 90/10 (S&P500/Cash) strategy for his beneficiaries, to simple dollar cost averaging into a target-date fund. In Pershing Square Holdings’ 2015 annual letter to shareholders Ackman discussed some of his errors.
“Principally, we missed the opportunity to trim or outright sell certain positions that approached our estimate of intrinsic value.”
“When the stock (Valeant, VRX) price rose this summer to the mid- $200s per share, we did not sell as we believed it was probable the company would likely complete additional transactions that would meaningfully increase intrinsic value. In retrospect, this was a very costly mistake.”
“We made a similar error in not trimming our Canadian Pacific (CP) position when it reached ~C$240 per share.”
“Our most glaring, albeit small, unforced error was buying additional stock in Platform Specialty Products (PAH) at $25 per share to assist the company in financing an acquisition.”
These errors dealt with buying and selling at the wrong time. I am sure that he has a system outlined and respect that he admitted to his errors. With a solid system, an investor can write down when to buy and sell a stock. The system would prevent these types of errors and not lead to statements such as, “I should have bought here”, or “ I should have sold there.”
Investing with Emotion
In 2014, I watched Bill Ackman (Trades, Portfolio)’s live presentation against Herbalife (HLF). If he was genuine, it was an emotional presentation for him claiming that Herbalife preys on the less fortunate. Investing should be a mechanical process. Once emotion gets involved, lapses in judgement tend to occur. He started betting against Herbalife when it was trading in the $40 range, and it is now at $65.25. He seemed to be too emotionally involved in his pyramid scheme claim and refused to acknowledge the possibility that he could be wrong. On Friday, the company was fined $200 million for its unfair and deceptive practices, but it was not charged as being a pyramid scheme. The stock was up 9.92% for the day.
Concentrated Investments
One of the first things that I learned about investing is to be diversified. It is impossible to know everything about a company, and those unknowns can creep up and bite you. If you have too much invested in that company, your portfolio might not live to play another day. Specific stock risk can easily be reduced. As a broker, I was mostly told that between 15 to 18 positions is the sweet spot. For all you home gamers out there, Jim Cramer says to put no more than 20% of your portfolio in a single sector. On a side note, my clients that followed Cramer’s system were successful because they could write down when to buy or sell. The people that got burned were the ones that blindly bought and sold without considering the system. Now back to Pershing Square. When looking back at Ackman's positions in the summer of 2015, his disclosed portfolio had 29.94% in Valeant and 19.46% in Air Products and Chemicals (APD). Nearly half of his disclosed portfolio was in those two companies. That is an extreme level of over-concentration. Since that disclosure, Valeant is down 89.7%. Air Products and Chemicals fared much better being up 9.2%, but having half of the portfolio in two positions is too much for comfort.
Penny Stocks
From what I have witnessed from working with thousands of people, penny stocks are the biggest portfolio killers out there. Low priced, over-the-counter stocks have much less requirements than the stocks on major exchanges. The one quote I remember from the Wolf of Wall Street is,
“…rich people don’t buy penny stocks. They just don’t. Why not? Because they’re too smart, that’s why not.”
The wolves of Wall Street are still out there, but not as brokers like in the movie. They now come in the form of stock promoters and executives of fake companies. I know enough of their tricks to write a book.
Ackman’s penny stocks are a special case though. He has investments in Fannie Mae (FNMA) and Freddie Mac (FMCC). As an activist investor in the companies, he and other fund managers have taken legal action against the U.S. government. They have a legitimate gripe, and I hope they succeed. These companies were bailed out by the government during the financial crisis by selling preferred stocks with a 10% dividend. Since Fannie and Freddie could not pay the 10% rate, the conditions were changed to the dividend being all of their profits. Since then, the companies have paid $247 billion in dividends according to the bailout tracker on the ProPublica site. In comparison, the bailout was for $187 billion, but Fannie and Freddie have not been allowed to buy back the preferreds since all of the profits have to be paid as dividends. If the legal case against the government works out, the investment could be a 10-bagger. If not, these stocks are worth nothing to the shareholders. It is a gamble. In November of 2013, it was disclosed that Pershing Square held 115 million shares of Fannie and 63 million Shares of Freddie. Since then the stocks are down 16.6% and 20.7%, respectively.
If you decide to invest in penny stocks, invest in companies that you know. Also you can check with the investing gurus that are tracked at GuruFocus. They have done their homework. Chuck Royce is the micro-cap stock guru on the site.
My Own Mistake: Don’t Believe the Hype
In one of my accounts I started to build a core position in Pershing Square Holdings as soon as it became public. I was mesmerized by Ackman’s nearly 20% annual returns and his 2014 40.4% gain. Afterward, I began to notice how high-flying hedge funds tend to underperform as soon as they become available to the general public. To name a few that I follow: Greenlight Re (GLRE), Third Point Re (TPRE), and Steel Partners (SPLP). To be fair, Daniel Loeb (Trades, Portfolio)’s Third Point Offshore Fund (TPNTF) has been beating the S&P 500 since it became public in 2007, it is his reinsurance company that has been underperforming. To prevent this mistake again, I have decided only to have small positions in these companies until I see at least ten years of outperforming the S&P 500 as a public company. These stocks do exist, and I will discuss them in an upcoming article.
When I was broker, I helped thousands of clients with their accounts. Avoiding these common mistakes will help keep you from losing money and therefore, increase your returns. When investing, remember to have a system, be diversified, don’t let emotions cloud your judgement, avoid penny stocks, and don’t believe the hype. As for Bill Ackman, let's hope that the recent poor performance is just a hiccup, and he can get back to making money for his shareholders.
Disclosure: I own shares of Greenlight Re, Third Point Re, Steel Partners, and Third Point Offshore.
