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Geoff Gannon Investor Questions Podcast #11: Why Does Evergreen Energy's Stock Always Go Down?

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Jun 07, 2010
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Evergreen Energy (EEE, Financial) is about to go bankrupt. That’s why the stock price has been going down. When Evergreen goes bankrupt people who own the stock will get nothing. Even people who loaned the company money will only get some of that money back.

In an earlier podcast, I talked about a score you can use to see what shape a company is in. It’s called the “Z-Score”. And it tell you how likely it is the company will go bankrupt in the next couple years. The Z-Score can help you avoid stocks where you will lose every penny you put in. I’m afraid Evergreen Energy is one of those stocks. A Z-Score above 3 is safe. A score between 1.81 and 3 is borderline. Any score less than 1.81 means the company is headed for bankruptcy. Evergreen scores a 0.6. I’ve never seen a stock score that low.

I didn’t need to calculate Evergreen’s Z-Score to see its about to go bankrupt.

In an earlier podcast, I talked about how I look for companies that have 10 straight years of positive free cash flow. Evergreen has 10 straight years of negative free cash flow. In 9 of the last 10 years the company had negative operating cash flow. That means more cash went out the door than came in even before the company spent a dime on building new stuff. The day-to-day business is so bad Evergreen would still lose money even if it stopped spending anything on its future.

Evergreen Energy is a speculative company. It’s a gamble. Or it was a gamble. Now it’s a sure thing to go bankrupt. Even now the stock isn’t cheap enough. The people buying and selling shares aren’t taking the risk of bankruptcy seriously enough.

Last I checked, shares of Evergreen Energy were trading at 17 cents. The company has just over 200 million shares outstanding. That means the market capitalization – or “market cap” – is around $34 million. To get the market cap, multiply the number of shares outstanding by the stock price. The number of shares outstanding is on the front page of the 10-Q and 10-K reports to the SEC.

You can see the 10-Q and 10-K reports at EDGAR. Just type the letters E-D-G-A-R in Google. Then click on the link that says “Next-Generation EDGAR system”. Then click on the link that starts with “company or fund name”. Then type “EEE” in the ticker symbol box. The third file down says “10-Q”. That’s the company’s quarterly report. Every 3 months, Evergreen sends a report to the SEC saying what its balance sheet looks like, how much money it made or lost, and other things like that.

You bought this stock. So I’m guessing you didn’t look at the SEC reports. That’s the first thing you should do. Always look at the latest 10-Q and 10-K. Always.

Although I talk about sites like GuruFocus and Morningstar – and those sites are great tools – they are only tools. Use them when you’re browsing for stocks. Don’t use them when you buy a stock. Always look at the real 10-Q and 10-K reports before you buy a stock.

The reports for Evergreen Energy are ugly.

Start with the balance sheet. That’s the most important financial statement. The balance sheet is where you find the biggest dangers. A company with a solid balance sheet won’t go bankrupt right away. Even if it loses a lot of money, it won’t go bankrupt for at least a couple years. That means you won’t lose all your money – at least not quickly – if you stick to buying only companies with good balance sheets.

Evergreen’s balance sheet is bad. It has $8.13 million in current assets. Current assets are things like cash, accounts receivable, and inventory.

The company has $22.93 million in current liabilities. That means it has negative working capital. Some companies can run fine with negative working capital. But it’s a bad sign for cash flow negative businesses to have negative working capital.

Think of a bathtub. The water in the tub is the stuff the company has that can be turned into cash. Then there’s the flow. Is the faucet open and pouring new water into the tub? Or is the drain open and sucking water out of the tub?

In this case, we know the drain is open. More cash is going out of the tub than coming in. That’s been true for most of the last 10 years.

When the tub is empty, the company goes bankrupt.

Evergreen has $8.13 million in current assets and $22.93 million in current liabilities. That means Evergreen’s stock of cash and stuff it expects to turn into cash is $14.8 million less than what it expects to pay out in the next year.

This negative working capital doesn’t come from Evergreen’s normal business. That amount is equal. You can check this yourself by looking at current liabilities and subtracting short-term debt. Without the short-term debt, Evergreen would have equal amounts of current assets and current liabilities. That’s what the business would look like if Evergreen didn’t have any debt.

The gap is all short-term debt. Evergreen owes $14.7 million that it has to pay this year. And it can’t make that payment.

If Evergreen was profitable there might be a solution here. Evergreen could borrow more money from someone else to pay off the debt that’s due this year. Good businesses do that all the time. They can do it because new lenders step up. The lenders know they’ll get paid off in the long-run.

But Evergreen isn’t a good business. It isn’t profitable. In fact, it has a long record of losing money even before it has to make interest payments on its debt.

Lenders aren’t stupid. They see what I see. They see Evergreen is headed for bankruptcy. So they won’t lend the company more money. Without new cash coming from the faucet, Evergreen’s tub will run dry.

Evergreen is headed for bankruptcy. And it’s getting there fast. On May 18th, holders of $28 million worth of Evergreen debt told the company it was in default. That means Evergreen has to pay those debts now.

A judge could agree with Evergreen and say the company is not in default. But for you - and everybody else who owns Evergreen stock - it doesn’t matter. Not if you’re going to hold onto your shares. Because one day those shares will be worthless.

Sell now. I know it’s hard to hear. I know it’s hard to take a loss. But it’s the right thing to do. Don’t think about the price you paid. That money is gone. You can’t do anything about that mistake. But you can make sure you don’t make another mistake.

Think of it this way: you own stock in Evergreen Energy. You own part of the business. That business is worthless. Believe me when I say that. It isn’t a question of whether Evergreen is worth 15 cents or 10 cents or 5 cents. It’s worth zero.

But there are people out there willing to buy this worthless piece of paper from you. The stock you own is junk. If you keep it you will end up with nothing. But someone is willing to pay 16 cents for it. Let them. It’s a good deal.

I know it doesn’t feel that way now. And it won’t feel that way after you sell the stock. But it’s the right thing to do.

Don’t think of stock prices as telling you what the company is worth. Just think of a stock price as an offer. That’s all it is. What matters is the value of the business. And the value of this business is zero. When someone offers you 16 cents for something that’s worth zero – that’s a bargain. Sell.

If they offer you 10 cents – sell. I don’t normally say this, but sell at any price. Evergreen Energy is literally worthless. Your stock is literally worthless. You need to sell it for whatever you can get.

Hopefully you can learn from this experience. Losing money hurts. Admitting a mistake hurts. But think about why you made that mistake. Think about how you didn’t look at the SEC report. How you didn’t look at the balance sheet. How you didn’t calculate the Z-Score. How you bought into a speculative company with years and years of losses.

The good news is that those mistakes are simple mistakes. They’re easy to fix. So sell your shares tomorrow. Take a day off. Forget about the money you lost. And think about the knowledge you gained. Write down the things you did wrong. And promise not to do them again.

Make a checklist. If you stick to investing after all this pain, that checklist will eventually be worth more than the money you lost in Evergreen. You have years ahead of you to invest. A good checklist can make you a lot of money. More importantly it can save you from losing a lot of money.

Here are my suggestions: #1) Make sure the stock has 10 straight years of positive free cash flow #2) Make sure the stock has a Z-Score higher than 3. And #3) Make sure the stock has an F-Score higher than 3. I would also add a 4th suggestion which is to look for a good price. But for now just think about picking companies that won’t go bankrupt. That will get you halfway to becoming a good investor. You can learn the other half later. First focus on not losing money. On never repeating this mistake.

It’s not hard if you write a checklist. Investing is simple. But it’s not easy. You have to be tough on yourself. Don’t gamble. This stock was a gamble. You knew that. In the future, when you know something is a gamble, you have to promise you won’t buy it. Never gamble.

That means using the checklist I told you about: 10 straight years of free cash, Z-Score over 3, and F-Score over 3. If a stock doesn’t meet all those requirements, forget about it. It’s not for you.

Remember you can afford to miss out on a great opportunity. You can’t afford to lose everything. If you keep yourself from gambling and stick to that checklist you won’t make that mistake again.

Thank you for your question. I know it’s tough to ask a question like that. And I’m sure it was tough hearing the answer. But I’m also sure hearing about your mistake will help others avoid the pain you’re going through.

That’s all for today’s show. If you have an investing question you want answered call 1-800-604-1929. That’s 1-800-604-1929.

Thanks for listening.





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