How to Lose $1 Billion a Day

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Check your emotions and ego at the door.

This is one of the most important lessons for any investor. You simply have to be able to see the simple, obvious signs that an investment isn't working and take the appropriate action — that is, sell.

Don't ask questions. Don't look for obscure reasons why you are actually right and all the other investors are wrong. This is no place for an ego trip. If a stock you've invested in isn't working like you thought it would, just sell it. Take the loss if there is one, and move on. There are 10,000 stocks out there; chances are pretty good that you can find a good one.

Of course, just admitting you're wrong and moving on is not the easiest thing to do. Like it or not, all of us have a tendency to fall in love with our investments. You do the research, weight the pros and cons, and by the time you plunk down your cash, you really do have an emotional investment in the stock.

But don't worry — we've all made these mistakes. That's how we learn what not to do. Still, it's nice when there's a story of a high-flying investor who's taking his lumps because he didn't learn this most basic lesson...

How to Lose $1 Billion in a Day

His name is Bill Ackman. His hedge fund is called Pershing Square. Yesterday, he lost $1 billion on one stock.

The stock is Valeant Pharmaceuticals (NYSE: VRX). Ackman has been aggressively long the stock for a couple of years now. Yesterday, Valeant shares fell over 50% after the company lowered its first-quarter earnings estimates from ~$2.35 a share to $1.30–$1.55 a share. That's pretty bad, but the warning is that it might actually violate debt covenants, too...

Yikes. That's bad. But it's not like there weren't warning signs. Valeant has $30 billion in debt for acquisitions, it has engaged in the ruthless, Shkreli-like markup of acquired drugs, and it recently admitted to some accounting issues.

All those issues should have made any investor re-think his or her position on the company. Accounting issues should pretty much always be a big red flag.

But not for Bill Ackman. He's been pounding the table about what a great investment Valeant is. Now, here's an excerpt form a Bloomberg article that details just how good of an investment Valeant has been for Ackman's Pershing Square:

Pershing Square's common stock position — some 21.6 million shares — lost more than $700 million in value today. Its stock options, for which it paid about $61.6 million back in the heady days of November, are now worth a large negative amount of money: Pershing Square bought call options that are now very far out of the money, and sold put options with a $60 strike price that are now — just as of today — uncomfortably in the money. Under those options, Ackman is on the hook to buy about 9.1 million shares of Valeant at $60; it closed today at $33.51. By my rough math Pershing Square's options positions lost almost $220 million of value today.

A $700 million loss on the stock, $60 million on some call options, and a $220 million loss on the short put options... in one day. And that's not even the worst of it...

In total, Bloomberg reports that Pershing Square has risked a total of $4.1 billion on Valeant. As of yesterday, that stake is worth around $500 million. So Ackman's total loss here is well over $3 billion.

Yesterday was so bad that Ackman had to write a letter to the people who have invested money with him. He wrote:

We [Pershing Square] are going to take a much more proactive role at the company to protect and maximize the value of our investment. We continue to believe that the value of the underlying business franchises that comprise Valeant are worth multiples of the current market price. Getting to those values, however, will require restoration of shareholder confidence in the management and governance of the company.

Yep, you read that right. He's not giving up. In fact, it sounds like he's poised to sink even more time and money into Valeant. Sounds to me like Ackman is in a death spiral, completely incapable of making the right decision.

Warning Signs

The funny/sad part of this is that Ackman has done this kind of thing before, though with less impressive results. As I've written before, it was Ackman that brought down J.C. Penney a few years ago:

Bill Ackman did this with J.C. Penney a few years ago. In fact, it's his fault JCP nearly went bankrupt. He bought $1 billion in JCP, got a seat on the board, and then pushed out the former CEO in order to bring in a new superstar CEO to make the company more exciting and push the share price higher.

Ackman wanted former Apple executive Ron Johnson, so that's what happened. Ron Johnson was a great success... if your goal is to piss off your customers, cut revenue in half, and spend all your available cash. And Johnson accomplished this amazing trifecta in just 18 months!

Johnson was fired, Ackman sold all his stock and lost $500 million, and JCP is working hard to simply get back to where it was before Ackman showed up.

Then there was Herbalife (NYSE: HLF). He called the company a Ponzi scheme and shorted $1 billion worth of the stock. (This is the investment where another hedge fund guy, Carl Icahn, took the long side, basically making money directly from Ackman's losses.)

It's estimated that Ackman needs Herbalife to be in the $30s to make money. The stock is currently trading around $58.

I don't wish bad luck on anyone. But I can't help but chuckle a little when a billionaire investor gets taken down by his egomaniacal inability to learn such a basic investing lesson.

Until next time,

Briton Ryle

@BritonRyle on Twitter

An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.