Sprint Nextel (S) made news yesterday because of allegations of tax fraud. Who knows where that will go but if you look at a long term chart you will see that in 1999 the stock was $70. Yesterday the stock closed at $2.40. Sprint was once a very widely held stock that did phenomenally well going up 2400% from its IPO to its peak in late 1999 (according to Yahoo Finance).
We have seen this type of demise before with the “safest” of names like Fannie Mae and stocks that probably never should have gone public like Pets.com. I think most people remember how revered Fannie and Freddie once were. Another one from the revered category was Cendant which may not be as familiar. There was a stretch in the mid 90s where Cendant was very popular as a staple holding for a lot of investment advisors (talking long before it blew up).
Fannie and Freddie were reasonably placed on the same pedestal as Coca Cola (KO) and client holding Johnson & Johnson (JNJ). Sprint too and many others that one way or another failed (either literally or effectively) were very highly regarded. How about the entire US auto industry? The carnage there has been epic.
If we did some sort of poll and built a portfolio of the 20 safest names to hold for the next ten years, like so many magazines are fond of doing, it would be a very good bet that at least a couple of them would disappear.
This is not to say that predicting a failure at Pepsi or Honeywell would be anything but a lucky guess but that is the point. Any stock can go to zero. Apple could disappear. Again, not a prediction as there is no visibility for any of these to fail but it happens and often there is no warning–at some point starting in 2003 there may have been visibility at Fannie and Freddie as Freddie got into some trouble over accounting issues.
If you can accept that anything can fail then the issue of position sizing becomes critical. This has been covered here many times in terms of targeting individual stocks at 2-3% of the portfolio as many others go with larger weightings for their holdings. Getting caught in something that fails is not the worst thing that can happen to an investor because it can happen to any company. It is bad to get caught with 10% of the portfolio in something that fails and this happens. Based on experience working at brokerage firms, anytime there is a spectacular one day implosion in some stock there are invariably investors with only that stock in their portfolios and they own it on margin.
An extreme example but it makes the point.