E-mail this article Printer-Friendly

What you can still learn from Enron when you pick stocks

Often common sense is all you need to make the right decisions, says this U.S. advisory, as it replaces one energy service stock with another.

Everybody remembers Enron. It was the scandal that wouldn’t quit. But we’re not here to rake Enron over the coals again. Instead, we find Enron held up as an example of how one simple piece of evidence may be all you need to make an investment decision.

In the latest issue of The Complete Investor we read the following: “Over the years we’ve learned that common sense can go a long way when it comes to making investment decisions. You can spend hours digging through financial statements, but often the best clues are right in front of you.”

In making the case for selling one stock in their Growth Portfolio and replacing it with another, Mr. Stephen Leeb and Mr. Ivan Martchev draw a parallel with the fall of the Enron empire.

So return with us now to the thrilling days of yesteryear (it’s been almost seven years now) while we see what Enron still has to tell us.

A huge red flag at Enron

In 2001, Enron was the king of the energy markets with its “new business model” of energy, finance and information technology all rolled into one snappy new-wave package.

“We must admit we didn’t begin to understand then how it was manipulating earnings by using off-balance sheet partnerships — that was the whole idea of those ruses,” say the authors.

(Wait a minute! Aren’t all those collateralized debt obligations off the balance sheets of financial institutions? The Enron model is alive and well!)

“But a huge red flag was raised by a simple, easily observable fact,” they continue. “In August, 2001 — just three weeks after appearing on the cover of Business Week as Enron’s boy wonder CEO and after only six months on the job — Jeffrey Skilling resigned from the company ‘to spend more time with his family’.”

At that point, sensing something was off, one of the authors called a friend who was enamored of Enron and advised him to sell (he didn’t). A few months later the company filed for bankruptcy.

This red flag has risen again in the authors’ current Growth Portfolio. The company also has an energy connection, but this time it’s an engineering and constuction (E&C) firm. Here’s the conundrum.

Raising hackles

“Enron is an extreme example,” say the authors, but their “hackles were raised” by an alarmingly similar incident. ABB Ltd. (NYSE-ABB), a Swiss-based giant that makes cutting-edge technology and automation for the power generation industry, held a firm place in the advisory’s Growth Portfolio.

Then the respected CEO, Mr. Fred Kindle, resigned to “spend more time with his family.” But why, ask the authors? “The energy infrastructure business is hot, Kindle has been on the job less than three years, and the company has been performing well. The explanation for his resignation just doesn’t ring true.”

They admit they may be making too much of this. But when their hackles are raised, they’re prepared to take “the better safe than sorry” route. They sold ABB and replaced it with Fluor (NYSE-FLR). Based in Dallas, Fluor has been doing engineering and construction work for the petroleum industry since 1912.

Like ABB, Fluor is in a strong business with excellent prospects. But since it doesn’t appear to have any skeletons preparing to leap out of the closet, it is simply a sounder investment at the moment.

Not skimping on spending

With the price of oil well into triple digits — $116.69 as of Friday — oil companies aren’t skimping on capital spending. For two decades, while oil prices remained in a much more modest range, energy firms “pushed the usable life of their infrastructure to the limit,” point out the authors.

Even when prices began to rise almost four years ago, many companies held back. Now even the most conservative companies are ready to spend. They’re upgrading what they’ve already got, and building new facilities to expand production from sources like oil sands and liquefied natural gas. They’re also moving into new forms of energy like coal-to-gas and coal-to-liquids technology.

Fluor is the largest and most versatile company in the sector. With all its subsidiaries, it has engineering services for oil and gas, chemicals and petrochemicals, transportation, mining and metals and even more industries. It can handle the biggest customers in each industry, and no one customer makes up more than 10 per cent of its total backlog.

Woefully outdated grid

The largest share of Fluor’s profits come from the oil and gas industry, however. Most E&C firms take no more than 40 per cent of their profits from oil and gas infrastructure: the figure at Fluor is over 50 per cent.

Oil and gas orders grew by more than 54 per cent in 2007 and there’s another area of growth that hasn’t really been heard from yet. America’s power grid is woefully outdated (remember the big blackout of 2003?) and Fluor’s power division is in a position to do something about it. It should keep busy for quite some time.

One final advantage is Fluor’s “cost plus” contracts. These guarantee the company a profit regardless of cost overruns. This comes in handy at a time when rising commodity prices can push up costs in a hurry.

By the way, the CEO of Fluor, Mr. Alan Boeckmann, who joined the company as an engineer in 1974 and has been at his current post since 2002, is apparently able to spend quality time away from the office without actually leaving his job.

The resignation of a CEO is not in itself reason to drop a stock, of course. But the authors’ point is well taken. There are times when something just doesn’t feel right — you may recall that the CEO of Bear Stearns firmly declared all was well just days before the firm caved in.

If your instincts are telling you that something is rotten in the state of a company in your portfolio, be prepared to act. Your common sense is as sound as anyone else’s.