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Avoiding Enron-Style Disasters

Three steps for keeping future Enrons out of your portfolio.

When a stock of a once-respected company falls from $90 to $4, it's hard to imagine the market wasn't overreacting. And in fact, we've received several notes from investors who went bottom fishing in Enron (ENE) shares before last week's final plunge. But in Enron's case, as we know now, the market was spot on. If you bought at $10, you bought a stock that had fallen 90% from its peak. The stock then proceeded to fall another 97%. It just goes to show stocks really do go to zero.

If you had followed our advice, you probably would have avoided the second 90% plunge, but not the first. Some investors have thanked us for writing a negative Analyst Report when the stock was at $10--at least we warned people not to bottom fish in this case. Understandably, other investors haven't been so generous. They've nailed us for being positive on the stock earlier this year, and for publishing a high rating on the stock (either four or five stars) for most of October and November.

No doubt about it, we should have been more negative. (If ever there was a humbling profession, it's stock analysis.) As more and more bad news came in about Enron, we kept lowering our fair value estimates. From $53 to $43, from $43 to $30, from $30 to $10 (where we came out and said "stay away"), and finally from $10 to zero. The problem was, the stock was falling even faster. So while our written reports had turned negative and did a good job of laying out what a stinker Enron was turning into, our fair values were too optimistic. (We archive our past reports, so you can see exactly what we were saying at each stage of the meltdown.)