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It's not too late to learn your lesson from the bankruptcy filing of Arch Coal, ACI

Tuesday, January 12th, 2016

I consistently warn investors of holding high valued stocks, and even worse is those high valued stocks with intangible assets and a lot of debt. Off the top of my head comes Tesla (yes I'm picking on them again and hopefully some will listen,) Amazon, Netflix, and Twitter which has fallen from a high of $53.49 to $19 (and change) this year; that’s a 64% drop if you’re curious about the percentage decline.

But let's flash back to a different time- 2011. Natural gas was expensive and would continue to rise for decades to come, or so everyone was saying. The best alternative was coal.

I know it sounds funny now, but no one has a crystal ball and coal was the hottest investment around. Investors would pay anything for a coal company and were paying 33.4 times current earnings for Arch coal. That is not forward earnings, which would be higher, that was current earnings.

The forward PE (based on December 2013 estimates at the time) was 21.1, with the stock price at $325 and estimated EPS OF $15.37. By 2013, the company was losing $35/ share and the stock was well below $50/share; roughly an 88% drop in the share price.

After 2011, things continued to get worse for investors as the company decided to apparently invest in another coal mine. The executives must have thought “how we could go wrong? The price of coal has continued to go up and this will be a huge money maker!”

Per the 10K (10k is a document filed with the securities exchange commission that tells all the details behind the scenes) for that year, they invested in another coal mine. Total debt climbed to $5.1 billion, and the equity fell from $3.6 billion to $2.8 billion by early 2012. The stock had been cut in half to about $150 and was cut in half again by December 31st, 2012.

At this point in time I'm sure some of the investors had gotten out, but I know many did not. It's human nature to say, "no things will get better, coal will come back up.”

The problem is that most people were buying the stock and the story, NOT looking at the financial statements. Now keep in mind no one (including myself) could tell the direction of where coal would go, BUT by looking at the fundamentals one could tell this company was in trouble and should have been sold. It never should have been bought at such high valuations in the first place.  Looking back at the numbers, there were so many warning signs.

The most recent balance sheet for the period ending September 30th 2015, the assets totaled $5.8 billion. However the liabilities have swelled to $6.5 billion, which means now the company has negative equity of $605 million.

Remember that mine the company bought back in 2011 after they borrowed a couple billion dollars for the investment? In the second quarter of this year, the company had to write down $2.1 billion in an asset impairment charge because the mine is now nearly worthless.

When the company goes to bankruptcy court, the payout of what is left is as follows: first the IRS gets paid, then the employees next in line would be the debt holders (of which currently stands around $5.1 billion) and could climb as other creditors climb on board, and then if there is anything left, the shareholders would split the balance. But with negative equity of $605 million, there will not be anything left for the shareholders.

Don't be fooled because the stock still trades on the exchange; it has now become nothing more than a gambling chip that is worthless. Traders will continue to trade it, hoping to make a few dollars here and there off of people hoping that it will come back. Let me state now- it won't!

So if you hold companies like a Tesla, you may be fine for now or maybe even for a few years to come. But if a company can't make any income, sooner or later the house will cave in from all the weight of the liabilities.

Learn your lesson now and become a smarter long-term investor!

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