Friday, August 22, 2008

Zero is Still Zero

If you watch the news, you won't be surprised to learn that Fannie Mae and Freddie Mac (and am I the only person who thinks those names are incredibly stupid?) have been having trouble lately. Today I read that Moody's cut the preferred share ratings on the two companies.

The section that caught my attention, however, read: Many analysts expect the government will have to exercise new abilities to recapitalize the companies, effectively nationalizing them. Those worries yanked their stock closer to zero this week from more than $65 a year ago.

The reason I found this amusing was the comparison of a stock at zero to that of a stock at $65 a year ago, like the fact that it was $65 a year ago is important. Would you rather have bought a stock for $65/share or $1/share and watch it go to zero?

It's a trick question--it doesn't matter. If the stock goes to zero, you've lost 100% of your investment. It doesn't matter at what price you bought in at--you lose 100% either way. Zero is the one stock price that your results will be exactly the same regardless of your buy-in price. It doesn't matter if you bought in at $100,000/share or 1 cent/share--you still lose 100% regardless if the stock price goes to zero.

The fact that the author of this article compares zero to $65 makes me think that the author of the article does not realize this point. It's not like someone who invested a year ago is hurting more than someone who bought in yesterday--they're both losing 100% of their investment. (Or at least heading in that direction--it's still not official as of yet.)

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