An investment figure and author works through a series of errors that he sees people make in trying to build wealth. Not all of the mistakes are particularly large, so he also mentions a few of the less damaging errors that arise.
A recent example demonstrating how lease liabilities can bring down a firm is WeWork. That company entered into $34 billion in lease commitments – even though it generates under $3 billion in yearly revenue. The new accounting rules made it impossible for WeWork to hide this unsustainable leverage from potential IPO investors – thus, the IPO failed and WeWork’s executives are still mopping up the mess.
In fact, there are many examples of companies with other forms of hidden leverage. For instance, Pacific Gas & Electric filed its record-setting bankruptcy as a result of its hidden leverage in the form of wildfire tort liabilities. Utilities were once thought of as safe and conservative investments, but PG&E’s example shows how tort liabilities can topple even the biggest firms. Boeing is another example of a big company with hidden leverage. It has underfunded pension liabilities as well as tort liabilities for plane crashes.
Moreover, it now faces legal claims from airlines who can’t use the grounded 737 Max planes they’ve already purchased from Boeing. The airline manufacturer’s stock was trading at about $400/share in February 2019, having increased in price five months after the crash of Lion Air Flight 610. After the Ethiopian Airlines catastrophe and the FAA’s decision to ground all 737 Max aircraft, its share price has dropped to the low $300’s and its outlook remains uncertain.
The main takeaway here is that before you put your money into any company, make sure you’ve done your homework and know what risks you are actually taking on with your purchase. Large passive ETF strategies ignore this rule by definition, which may give us fundamental investors an advantage over time.
When it comes to distressed investing, the primary lesson is that investors should be extremely cautious with over leveraged firms – including those with disguised debt. Whether it’s lease liabilities, underfunded pension liabilities, underfunded employee healthcare liabilities, tort liabilities, or any other thing that can be reasonably considered analogous to debt, you should be alert when you see it. In fact, you should avoid investing in any company with those kinds of liabilities, unless the price is commensurately attractive compared with the risk of future distress and insolvency.
The corollary lesson is that, no matter how diligent your research, you might still be wrong. Don’t be afraid to admit it and cut your losses quickly. Learning from other investors’ mistakes could make it a lot easier to follow the main investing rule to “never lose money.”
George J Schultze is the chief executive of Schultze Asset Management, a firm he founded in 1998. Widely recognized as an expert on distressed and special situations investing, he is the author of The Art of Vulture Investing: Adventures in Distressed Securities Management (Wiley Finance, 2012). He can be reached via email at: email@example.com