TMF
Portfolio Report
SmallCap Investing
2001 Small-Cap Lessons
By Rex Moore
January 7, 2002
Most of us were more than happy to say good-bye
to 2001, and we're all looking for better things in 2002.
As investors, it's always great to start with a clean
slate, especially after two consecutive down years in
the market. But we don't want to forget about the past
entirely, because history always provides us with valuable
learning opportunities.
In that spirit, let's take a look at a couple of stocks
that were among the best- and worst-performing small caps
in 2001, and see if we can glean a valuable lesson or
two from them.
To come up with our version of the worst-performing small
cap, I ran a screen with just three variables:
The first two variables were simply designed to limit
our companies to small caps. The $1 billion cutoff was
entirely arbitrary on my part, and the $500 million revenue
cap comes straight from the list of Foolish Eight criteria.
Here are the five worst-performing small-cap stocks of
2001, then, as provided by my extremely unscientific screen:
Company 2001 return 1. Brokat Aktiengesellschaft Ads (OTC:
BROAQ) -97.5% 2. iAsiaWorks (Nasdaq: IAWK) -97.3% 3. CoreComm
Limited (Nasdaq: COMM) -96.8% 4. Pinnacle Holdings (Nasdaq:
BIGT) -96.2% 5. Classic Vacation Group (AMEX: CLV) -96.2%
I eliminated Brokat Aktiengesellschaft for our purposes,
because it's a German outfit and information for it is
hard to come by; it's not likely a company we would have
considered buying in the first place. It collapsed under
its own debt load in 2001 and filed for bankruptcy. (Also,
I can't pronounce the doggone name.)
I dropped iAsiaWorks and CoreComm from consideration because
each was trading under $5 last January, and as Foolish
investors we likely would have avoided them also. The
same goes for Classic Vacation.
Pinnacle Holdings will work for us, however: It began
2001 around the $9 mark, and like a star in the latter
stages of its life it flared up briefly above $12, then
started a slow and steady descent, and has now almost
completely collapsed in on itself... trading at just $0.33
a share.
Pinnacle's business is fairly straightforward: It rents
space on communications sites -- such as towers -- to
providers of wireless communications services. Its "tenants"
include such names as BellSouth (NYSE: BLS), Motorola
(NYSE: MOT), Nextel (Nasdaq: NXTL), Skytel, Sprint PCS
(NYSE: PCS), and Verizon (NYSE: VZ), as well as the FBI
and the Bureau of Alcohol, Tobacco & Firearms. "
Pinnacle's tenants are generally responsible for the installation
and maintenance of their own equipment on the sites, and
its business scales well because each added customer requires
little in the way of incremental costs.
Potential investors may have eyed Pinnacle as a "bargain"
last January. It announced in August of 2000 that it was
under SEC investigation for improperly accounting for
the acquisition of Motorola's North American antenna site
business in 1999 and the stock fell from roughly $50 in
August to $9 by January of 2001. During that period, management
said it was fully cooperating with the SEC to get the
matter resolved as quickly as possible.
It's always easy to point out things in hindsight, and
I know there were a lot of people agonizing over this
stock early last year, wondering how it could go any lower.
But I'll bring up our first valuable lesson here from
Pinnacle's fall, and it's a rule I try to follow personally:
As soon as hints of impropriety begin to surface, especially
when the SEC is involved, sell the stock. (Let me state
here that I'm not talking about rumors spread by short
sellers or others with a financial interest in the stock.)
Time after time I've seen companies hit hard after bad
news like this first comes to light, only to fall even
dramatically farther in the ensuing days and weeks.
Sure, maybe there's an exception to this rule now and
then, but I'll bet you can think of a lot more instances
where a company continues to lose significant value well
after such news first comes out. For me, it's just not
worth the time and energy to continue to hold the stock
and sweat through SEC investigations and the like when
there are so many other investments out there to consider.
Just a month ago, Pinnacle settled with the SEC and received
a mere slap on the wrist. Without admitting or denying
guilt, the company agreed to the SEC's order to "cease
and desist from committing or causing violations of the
reporting, books and records, and internal control provisions
of the federal securities laws." No fines or any
other punishment were imposed.
As we've seen, though, that favorable settlement with
the SEC did not help the company at all during 2001. In
March, chief financial officer Jeffrey Card resigned.
Class action lawsuits were filed, alleging that executives
misled investors as to the company's business and financial
condition. The investigation weighed down Pinnacle so
much it had to cancel plans for a secondary offering,
and it admitted it was "unable to access the equity
and debt markets on attractive terms." Additionally,
management restated some past financial statements...
a move that had little impact on prior earnings but rattled
investors nonetheless.
My point is best made by Pinnacle itself in the company's
most recent 10-Q: "We cannot predict the outcome
of the SEC's investigation. Regardless of the outcome,
however, we have incurred substantial costs and the investigation
has caused a diversion of our management's time and attention."
For small companies, especially, this kind of diversion
can be extremely damaging.
There were some other signs to warn away investors, as
well. The 10-K issued in April raised a red flag about
the churn rate (the number of customers discontinuing
business with Pinnacle) and pointed to a possible technological
sea change that could negatively impact business: "We
experienced a level of churn by our tenants in 2000 that
was higher than our historical level of churn due primarily,
we believe, to changes in certain customers' underlying
communications technology resulting in a decrease in their
need to retain their equipment on certain of our towers."
All in all, while it may have been tempting to buy Pinnacle
at "bargain prices" during 2001, its trials
and tribulations illustrate why it's best to avoid companies,
especially small caps, that have their resources tied
up in non-productive matters.
That's all the time we have for this week; next Monday
we'll take a look at our best-performing small cap of
2001, PEC Solutions (Nasdaq: PECS). Why not familiarize
yourself with the company ahead of time, and let us know
what signs we could have seen early last year that PECS
would flex its muscles and return 362%? Post your thoughts
on our Foolish Eight discussion board, and I'll reprint
some of the best ideas in Monday's column.
See you next week!
Rex Moore salutes another of his former schools, Anderson
High School in Austin, Texas. Go Trojans! At the time
of publication, he owned no companies mentioned in this
article. The Fool's disclosure policy is still on the
New York Times best-seller list (at #23,677).
