From Titan to Financial Trainwreck - A Unicorn That Wasn't
How Analysts and Other Tricks Helped Praise a Company Until It Crashed
A warm hello to all new readers! I’m glad you are on board.
New here? I’m Michael and on a mission to make beating the stock market as easy for you as choosing your favorite ice cream. I write an algorithm that does exactly that.
How it all started. The journey so far.
When the smoke clears, investors learn the hard way
that even the brightest unicorns can be illusions.
Do you remember the 90s? If not - it was the era of flannel shirts and a stock market so bullish that it punched through many red flags and kept going higher and higher. The air was dense with promises of a digital revolution. One of the brightest stars was none other than WorldCom. A telecommunications giant promising a lot - and therefore perceived as a unicorn - destined for greatness. Or so everyone thought.
Once Upon a Time …
WorldCom was the knight in shining armor. Founded in 1983 as “Long Distance Discount Services”, it started gobbling up smaller companies faster than Pac-Man. The summit of this acquisition marathon came in 1998 with the purchase of MCI Communications finally forming MCI WorldCom - which transformed WorldCom into a giant.
WorldCom’s CEO, Bernie Ebbers, a charismatic guy told, or better “sold”, endless dreams of endless growth and domination. As a result, the company’s stock soared, and investors were head-in-the-clouds, seeing nothing but rainbows and dollar signs.
The Cheerleaders
Analysts - Wall Street’s oracles - with their crystal balls (aka spreadsheets), declared WorldCom is the next big thing. Jack Grubman from Salomon Smith Barney was one of the most vocal ones. Grubman wasn’t just bullish; no, he was the matador waving a red cape, encouraging investors to join the game. Grubman and his tribe continued to hype WorldCom as the golden goose, ignoring growing concerns and red flags that could’ve been seen from space.
It wasn’t just about analysis, though. Grubman, a man whose enthusiasm could’ve powered the Nasdaq, had a vested interest. He had deep ties with WorldCom’s top bulls, and his unwavering support earned him quite a reputation - and finally, a hefty fine later on. But we’ll get there in a minute.
Cheap Tricks
By the early 2000s, the tech bubble was popping, and former unicorns were looking a bit like old nags. Behind the glittering façade, an ugly reality lurked. To keep up the illusion of unending growth, the company engaged in some rather creative accounting practices - tricks that would make even the most seasoned magician awe.
The core of WorldCom’s deception was in its manipulation of write-downs and expenses. The company reclassified operating expenses as capital expenditures, effectively spreading costs over many years rather than reporting them immediately. This sleight of hand inflated profits and kept the stock price artificially high. It was like painting stripes on a donkey and calling it a zebra - well, eventually, someone was bound to notice.
A Unicorns Poop
The House of Cards crashed in 2002. WorldCom announced it had overstated its earnings by a couple of billion, a figure that would later balloon to $79.5 billion. Investors were outraged, employees devastated, and the stock world was shaken to its core.
WorldCom’s bankruptcy filing in July of 2002 was the largest in U.S. history surpassing even Enron’s collapse. The impact was immense. The bankruptcy ruined countless lives and destinies. And amidst the rubble, one couldn’t help but recall the analysts who had sung WorldCom’s praises until the very end.
THE Cheerleader
Let’s circle back to Jack Grubman, the analyst who could’ve sold ice to Eskimos. Grubman’s unrelenting support for WorldCom wasn’t just misguided optimism—it was a conflict of interest on steroids. His close relationship with WorldCom’s executives, particularly Bernie Ebbers, was more than just professional admiration; it was a cozy relationship that ultimately cost him dearly.
In 2003, the SEC fined Grubman $15 million and exiled him from the industry for life. It turned out that Grubman’s recommendations were influenced by his firm’s investment banking relationships, and he had misled investors. It was a scandal that made people question the integrity of all financial analysts.
Lessons Learned (hopefully)
WorldCom’s spectacular rise and equally dramatic fall left an indelible mark on the corporate world. It was a testament to what happens when ambition overtakes ethics and when the search for money growth blinds companies, their cheerleaders - and investors.
In the aftermath, regulatory bodies tightened the reins on corporate governance and financial transparency. The Sarbanes-Oxley Act of 2002 was a direct response to the accounting tricks at WorldCom, aiming to restore public confidence in the markets.
But beyond this changes, WorldCom’s story is a reminder for all of us. The importance of questioning the narratives spun by those with a vested interest. After all, if something seems too good to be true, it probably is.
Scanning the fundamentals for fraud is not just important - it’s critical. Investors must go beyond the surface-level charm of rosy earnings reports and skyrocketing stock prices, one can uncover potential red flags that might show underlying deception.
A Myth Is Born
Today, the names WorldCom and Enron are synonymous with corporate fraud and unchecked ambition. A monument of the 90s, a time when the internet promised everything and companies were eager to ride the wave, no matter the cost - just like AI today. So be careful.
In the end, WorldCom wasn’t magical; it was just a really good illusion. And like all good illusions, once you see the trick, the magic is gone.
But its story lives on.
Which brings us right to what I did this week.
Behind the Scenes
The Progress
Last week I told you that I’m about to finish the code to calculate share liquidity. I walked the talk from the article above and dug deeper – and the idea - evolved. I don’t just want to set a simple threshold because, with a couple of calculations, I’m confident that I can bring down the return volatility as well. Which means, this week I mostly invested time into more research and yesterday I started the implementation.
The basic idea is this.
If the trading volume volatility of a stock is high, it’s a sign that it’s not liquid and if we exclude these shares, the entire portfolio should benefit. It’s like changing the lane from the bumpy side of the highway to the smoother one.
The Plan
Implement the above idea!
What’s on my head
Nothing fancy this week, just work.
Nuggets I’ve enjoyed
I started reading Seneca's “Letters from a Stoic” (no affiliate link). It’s fascinating how reflected this guy was. A brilliant book – it’s like you are listening to your wise grandfather as he is giving you advice. Here is just one from page 43.
“Retire into yourself as much as you can. Associate with people who are likely to improve you. Welcome those whom you are capable of improving. The process is a mutual one: men learn as they teach.”
Hit that heart if you love knowing more!
Michael
Recommend The Economy Rocket to your readers and friends
I share my stock investment story without sugarcoating – you get the good, the bad, and those tricky ego trips. I'm developing a service with a mix of smart code and proven investment strategies, making stock analysis a thing of the past if you wish. Why? Because life offers so much more beyond the confines of stock analysis.
Disclaimer:
The information in this article is my personal opinion. I’m not a certified investment professional. It is not consulting, nor does it constitute investment recommendations.
I do my research carefully and follow my personal investment strategy.
The stock market is a complex building with its own rules. There are no rules set in stone, like the rules of physics.
Therefore, use the contents of this newsletter at your own risk and do your own research as well. Investing in the stock market can lead to a total loss of the capital invested.