Every investor makes mistakes, even Warren Buffett. What turns an honest mistake into an incredibly stupid error isn't so much the initial mistake -- it's making it an even bigger problem by compounding it and making the same mistake again. I got burned by the siren song that is Life Partners Holdings (NAS: LPHI) by not only investing once, but by also turning around and buying more, even as its business was clearly falling apart.
The story on the stock
When I first came across the company, it looked like an almost ideal investment. It had what looked like an incredibly strong balance sheet, with far more cash than total liabilities. It was raking in millions in profits, while competing in the rather macabre industry of selling life settlements, that likely scared away more squeamish investors. It paid a large dividend that had been growing at a rapid clip. And to top it all off, it had been recently featured as one of the fastest growing companies around.
Indeed, it almost seemed too good to be true. Small, rapidly growing companies rarely pay dividends, because they're busy plowing whatever cash they generate into building the business. Networking kingpin Cisco Systems (NAS: CSCO) , for instance, didn't initiate its dividend until 2011, years after it had already grown large enough to dominate its industry. Yet there was Life Partners Holdings, handing out a large cash bounty that looked to the outside world as if it were based on hard-earned income.
What went wrong
Not long after I initially invested, the Wall Street Journal came out with a hard-hitting article that called into question the very core of the company's operations. In essence, the people whose insurance policies Life Partners was selling weren't dying nearly as quickly as the company's life expectancy estimates anticipated they would.
That's a problem, because the entire investing thesis for those buying life settlements from Life Partners was based on how long the insured people behind those policies would live. Longer life expectancies meant smaller payouts and returns on investment, making the company's entire business model significantly less profitable.
Where I went wrong, though, was in presuming the company would want to immediately fix that very glaring problem. My thought process was that the business could still be profitable -- but with smaller margins and slower growth -- by using more reasonable life expectancies. Yes, it would be expensive, but it would be survivable for the company. By that (incorrect) logic, the stock seemed cheap enough for me to buy more shares. That error is what truly got me burned by the stock.
In reality, things didn't turn out nearly that well. The Wall Street Journal piece was published in late 2010. By early 2012, things remained so incredibly broken, that the U.S. Securities and Exchange Commission filed suit against the company and its top executives for alleged fraud and insider trading.
This is a big deal. Keep in mind, not long before filing that suit, the SEC had offered to settle with Citigroup (NYS: C) for what amounted to a 'slap on the wrist' for that bank's role in the subprime mortgage meltdown. That disparate treatment suggests to me that either the SEC was playing politics rather than protecting investors -- or that it really thinks it has a strong case against Life Partners. Either way, the one inescapable conclusion should have been "stay away." Instead, I made a bad situation worse by buying more stock after the issues became public.
The most important lesson I learned from this debacle is that, when investing in the anticipation of a turnaround, look for signs that the company is actually trying to turn its business around. As a successful turnaround, General Electric (NYS: GE) refocused on its industrial operations when an over-reliance on its capital business proved nearly fatal. Life Partners, on the other hand, still apparently prefers to follow the strategy of 'business as usual,' in spite of the very real issues facing the company.
The other key lesson I learned -- or rather, re-learned -- is that every investment should be made on the actual merits of the company under consideration, not based on what might happen if all the stars align. Making the initial investment in Life Partners Holdings seemed justifiable at the time based on what I could see. Making the follow up investment based on the mere potential of a turnaround -- after reality reared its ugly head -- was clearly not justifiable.
They're expensive lessons -- but ones that are certainly worthwhile -- if truly learned and acted upon.
The article Life Partners Holdings: The Stock That Burned Me originally appeared on Fool.com.
At the time of publication, Fool contributorChuck Salettaowned shares of General Electric, Cisco Systems, and Life Partners Holdings, though he's not sure why he's still holding the Life Partners shares.Click hereto see his holdings and a short bio.The Motley Fool owns shares of Citigroup and Cisco Systems. The Motley Fool has adisclosure policy.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.