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Fat Tails, Fires and Your Investments

Arson was just the tip of the iceberg. For years the company had been inflating its sales and inventory figures; the latter allowing the company to increase line of credit borrowings. In the end, shareholders lost millions, and some company executive faced jail sentences.

This was a true "fat tail" event, but hindsight showed some warning signs that I'd ignored, and the lessons learned have altered my investment philosophy. I'd purchased shares of Allou because it was a net/net, but I'd ignored the quality of the balance sheet. The current assets were comprised mainly of receivables and inventories; there was little cash. In my future purchases of net/nets I required higher levels of cash and short-term securities, and discounted the value of inventories and receivables. As investors, we all make mistakes; the important thing is to try and learn from those mistakes.


Ironically, just last week, I received a check from the Allou class action lawsuit, nearly 11 years after the company went up in smoke literally. Proceeds were less than 50 cents per share, but in total it would have been enough to cover several trips to that Chinese buffet restaurant. Unfortunately, that went up in smoke too.

"Fat tail" events will happen; be prepared. As an investor, that means avoiding portfolio concentration, and spreading the risk; across companies and asset classes.

Jonathan Heller, CFA, is president of KEJ Financial Advisors, his fee-only financial planning company. Jon spent 17 years at Bloomberg Financial Markets in various roles, from 1989 until 2005. He ran Bloomberg's Equity Fundamental Research Department from 1994 until 1998, when he assumed responsibility for Bloomberg's Equity Data Research Department. In 2001, he joined Bloomberg's Publishing group as senior markets editor and writer for Bloomberg Personal Finance Magazine, and an associate editor and contributor for Bloomberg Markets Magazine. In 2005, he joined SEI Investments as director of investment communications within SEI's Investment Management Unit.

Jon is also the founder of the Cheap Stocks Web site, a site dedicated to deep-value investing. He has an undergraduate degree from Grove City College and an MBA from Rider University, where he has also served on the adjunct faculty; he is also a CFA charter holder.

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