If you’ve been paying attention to the financial media in the last few weeks you’ve probably seen the drama surrounding a company named Valeant. In case you’ve been buried in your bunker waiting for China to blow up the global economy, here’s the short version – Valeant is a pharmaceutical company that has basically acquired its way to massive growth by gobbling up smaller firms, raising prices and restructuring. They’ve become a pharmacy, but with huge pricing power thanks to their increased monopoly power. Anyhow, a number of research outfits have come out in recent months discussing various accounting and corporate discrepancies. Some have even called Valeant the next Enron.
Anyhow, the stock has been sliced by 70% in the last few months. And this situation raises all sorts of thoughts for investors:
- Should most investors be involved in asset allocation that exposes them to so much single entity risk?
- If your answer is no, then indexing is your obvious route.
- If your answer is yes, then you better have a damn good way of analyzing the risks in your portfolio so as to reduce single entity risk.
And this is where a lot of stock pickers get into trouble. While indexing reflects the positive sum nature of the economy over long periods of time stock picking can often times look more like negative sum gambling (especially when done in a highly active, tax and fee inefficient manner). In the case of something like Valeant it can actually look like something worse than gambling. After all, when you gamble, you are playing a negative sum game where the probable outcomes can be calculated. But in the case of Valeant we have no idea what the probable outcomes are. After all, if this is a fraud then the stock is going to $0. Does anyone except insiders really know at this point? I doubt it.
Gambling isn’t what people should do with their savings. And that’s part of what makes stock picking so risky at times. You’re dealing with complex components of a complex system where you can’t possibly know the possible outcomes at times. So ask yourself – are you a saver or a gambler? I don’t know what your answer is, but in either case you can probably calculate the simple odds about what my concluding thoughts here would be.