1 Epic Stock Meltdown and What Investors Should Learn from This Cautionary Tale

Not too long ago in August 2015, the US-listed drug company Valeant Pharmaceuticals was worth almost US$90 billion. But today, Valeant’s market capitalisation sits at just US$8.2 billion after its share price had fallen by over 90% from its peak.

The company’s fall from grace was chronicled in a recent Vanity Fair article. What makes this tale interesting was the number of well-regarded fund managers who found themselves in the receiving end of the company’s epic meltdown.

The hedge fund hotel

“They livin’ it up at the Hotel California, What a nice surprise (what a nice surprise), Bring your alibis.”

– Lyrics to the song Hotel California

It would be an understatement to say that shares of Valeant was a favourite among fund managers.

In fact, hedge funds had piled into shares of Valeant to the point that the company was referred to as a hedge fund hotel – that is, a stock with high hedge fund ownership. But, the confidence in the company shown by multiple hedge fund managers did not materialise into the gains that the funds were hoping for.

There could be lessons from this cautionary tale.

Safety in numbers

Author and financial journalist Jason Zweig may have a description for the hedge fund managers’ behaviour. In his book, Your Money and Your Brain, he described a phenomenon called “safety in numbers.” Zweig said:

“You look around and find a large support group all expressing similar views – so you feel safety in numbers.”

In the Valeant case, it is possible that the hedge funds found safety in company, knowing that their peers were in the same investment. This, in turn, could have led to bigger and bigger bets by the funds. But as we now know, that didn’t turn out well.

Unfortunately, the Singapore stock market is not immune to such a phenomenon as well.

The case of Blumont Group Ltd (SGX: A33) might be one such example. In August 2012, the company’s share price was just S$0.06. Barely a year later, Blumont’s share price increased by almost 4,000% to peak at S$2.45 in September 2013.

Take a look at the chart below to see what happened next.

2016-06-08 Blumont Stock Price
Source: Google Finance 

As my colleague Chong Ser Jing had previously noted, Blumont’s shares were valued at 500 times trailing earnings near its peak. As more money chased the company’s share price up from August 2012 to September 2013, the stock became an increasingly risky investment.

At the time of writing, Blumont’s shares are trading at S$0.001 each.

Foolish takeaway

The cautionary tale involving Valeant has an important lesson.

As investors, we may want to have our own reasons for investing in a particular company. Having a big name investor buying the same stock as you may not be a good enough reason.

As Benjamin Graham once noted:

“You’re neither right nor wrong because other people agree with you. You’re right because your facts are right and your reasoning is right—and that’s the only thing that makes you right. And if your facts and reasoning are right, you don’t have to worry about anybody else.”

I couldn’t have said it any better.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn't own shares in any company mentioned.