Tuesday, July 31, 2007

Minus 87.4%

About 1½ weeks ago, a friend of mine told me he had invested in an American subprime lender and asked me what I thought about it. He said he knew they had problems, but he wanted to take advantage of their currently low stock prices and so receive high returns once the market turns around. My reply was that while his strategy was a good one under some circumstances, he had gone into the sector far too early. I told him it won't turn around until sometime next year-or even later. Until then the risk is too high and the chance of a near future turnaround is too low for investing in them.

He took my advice and sold his shares at a small loss. But he can be glad he took my advice as shares of most subprime lenders have fallen dramatically since-far more than the overall stock averages.

The case of American Home Mortgage serves as an illustration of just how high the risk is. Its shares fell a full 87.4% today (This from a level more than 70% lower than in December 2006), after news that it can no longer fund its home loans. This means that there is a very high risk that the company will go bankrupt or is forced to some other solution which would basically wipe out shareholder value. By now, the stock is a mere lottery ticket given the high risk of failure-and the potentially extremely high returns in the unlikely event that shareholder value will somehow be preserved. I still think the worst has yet to come, so I still wouldn't recommend anyone to buy stocks of subprime lenders unless it is one of particularly sound business practices compared to others-or unless you want a substitute for regular lottery tickets.


Post a Comment

<< Home