Nortel’s dive is painful lesson

If you’re like me, opening your investment account statement has been a disheartening experience lately. The TSE 300 lost almost 15 per cent in the first quarter alone. Tumbling stock markets have eaten away the returns on our investments at an alarming pace.

As most of us know, one of the main culprits in the drastic downturn has been the Canadian telecommunications giant, Nortel Networks. At the end of the first quarter of this year, Nortel’s stock was trading about $100 lower than just six months earlier.

From the towers of Bay Street to corner coffee shops across the country, the company’s misfortunes have been analyzed widely, but the full impact of Nortel’s collapsing stock price is difficult to gauge. Even if you’re not an active investor in stocks, you’re not insulated from all the turmoil surrounding the company.

Nortel’s presence
Nortel’s dominance of the Canadian economy and its weighty presence on the TSE 300 meant that many mutual funds and company pension funds-even the Canada Pension Plan-held stock in this technology giant. (Granted, most pension funds are large enough and have long enough time horizons that there’s litt danger plan members will suffer.)

It’s very difficult to understand how a company can go from being stock market darling to the scourge of investors in a matter of mere months. Initially, the plummeting stock price came out of the company’s sudden announcement of drastically lower projections for its financial performance.

The economic slowdown in the U.S. turned out to be bigger than first expected, said Nortel chairman John Roth. Still, how is it possible to be so far off base?  How could advisers and analysts have missed so many of the warning signs about the company’s real situation? Accusations abound and even a few lawsuits are even in the works.

Wrong advice
For me, this is the most unnerving part of these events-just how hugely wrong professional analysts were about the company’s prospects. And Nortel isn’t an isolated example. Recent stock-market history is full of examples of momentous declines in technology stocks. Most of us know at least one person whose ‘sure-thing’ investment in a dot-com company has bombed big time.

In the end, many of us are considerably poorer (at least on paper) and feel humbled by the experience. But if there is an upside to recent events, it is some of the basic truths about investing that have been brought home sharply by the Nortel fiasco.

Credibility important
Ironically, at a time when so-called independent investment research is now more widely available to do-it-yourself investors than ever before, credibility has emerged as a major issue. Investors must keep in mind that there may be some conflict of interest in selling. For instance, the company whose stock is being touted could very likely be a corporate client of the brokerage firm you’re dealing with.

Even without such a specific interest, brokers are in the business of selling so they tend to be unreasonably optimistic.
As well, in the wake of Nortel, regulators have reportedly launched a review of the way technology companies report their financial data. It seems that accounting can easily disguise poor earnings records in favour of expectations for future earnings.

Human nature
However, amid all the rationalizing, the truth remains: even the most intelligent investors and competent analysts ignored warning signs about Nortel, choosing to hear only inspiring predictions about the rosy future of a global giant that is Canadian.

It’s human nature to want to believe. It’s also natural to want to be in on the action, and it’s long been documented that investor sentiment has a profound effect on stock market movements. If we take anything from recent experiences, it should be that, in investing-as in life-blindly following the crowd can be a dangerous pursuit.