BIO: Brian Feroldi is a financial educator, YouTuber, and author. His career mission statement is “to demystify finance.”
STORY: Brian invested in an oil pipeline company with take-or-pay contracts. This meant that the company would get paid either way if the price of oil or natural gas went up or down. Prices went down and despite the contract, the pipeline’s stock went down because its customers couldn’t afford to pay. Brian lost 70% of his entire portfolio.
LEARNING: Don’t use options as an investment strategy. Never let one company become your largest position. Be careful about trying to leverage beyond your capability.
“When my research makes me unbelievably bullish about something, that probably means I’m blind to some risk.”
Brian Feroldi
Guest profile
Brian Feroldi is a financial educator, YouTuber, and author. His career mission statement is “to demystify finance.” He loves to help other people do better with their money, especially their investments. He has written more than 3,000 articles on stocks, investing, and personal finance for the Motley Fool.
Worst investment ever
Brian invested in a company in 2013, about nine years into his investing journey. Though not an expert, he completely understood business fundamentals. He had a framework for what kind of companies he was going after. The company Brian invested in was Kinder Morgan, an oil pipeline company. That means they don’t go out and find the oil but own and operate pipelines that move oil and natural gas from the extraction point to a processing plant. The company then takes a fee for moving the oil.
What really attracted Brian to that business model was that it had take-or-pay contracts in place. Meaning that if the price of oil or natural gas went up or down, Kinder Morgan would get paid either way.
In theory, this company had locked in guaranteed recurring revenue. In addition, it was run by its founder, Richard Kinder, who owned tons of stock and continually bought more. The company had a 4% dividend yield at the time, plus a realistic growth plan for them to expand that dividend by about 10% per year. So from the outside, it looked like a very low-risk company that could earn Brian a high dividend yield.
The more Brian studied the company, the more bullish he became on its potential. So over time, he would add to the stock because he thought it was attractive. Within no time, Kinder Morgan became Brian’s number one position.
At the time, Brian was learning about options and how they work. He set up a synthetic long on Kinder Morgan. Synthetic long is when you sell a long-dated put, which brings in cash today, and you use that cash to buy a long-dated call option. Essentially, you get to benefit from the upside. So if that stock goes up, you get paid for that stock to go up ahead of time. So the returns to the investor are enormous on a percentage basis. The downside to a synthetic long is if the stock price falls, you’re on the hook for pure leverage because you don’t own the shares. Brian’s confidence level in this thing was sky-high because it looked so bulletproof. After he set up this position, the oil and natural gas prices suddenly tanked by more than 50%. There was simply an oversupply on the market.
What confused Brian at the time was that Kinder Morgan’s stock was going down a lot during this downturn. The company had take-or-pay contracts in place, and it got paid no matter the energy price, so why was this stock going down?
Even though Brian’s position was in the red, he added to it because he believed it would recover and go up. Kinder Morgan’s stock ended up falling 70%. This was because the take or pay contracts only matter if the person on the other side of the transaction can afford to meet their end of the agreement. So while the company had a guaranteed locked-in revenue in place, those customers were dependent on the price of oil and natural gas and were hurting. The customers literally couldn’t pay. Once Brian eventually learned that, he capitulated and took up the largest loss he’s ever taken.
Lessons learned
- Don’t use options as an investment strategy.
- Never let one company become your largest position. Instead, put a little capital into different companies and watch them grow and flourish.
- Be careful when investing in an industry that depends on market price luck for the investment to work out.
- When your research makes you unbelievably bullish about something, you’re likely blind to some risk.
- Have some rules for the maximum amount you want to put into an idea because you can still be wrong no matter how confident you are.
Andrew’s takeaways
- Don’t be seduced by your research about a company that fits in the supply chain.
- Contracts can be renegotiated. So if you find yourself in a bad situation, talk to the people you signed a contract with and renegotiate the terms.
- Be careful about trying to leverage beyond your capability.
Actionable advice
Write down a list of the possible business risks you want to avoid. Then whenever you’re researching an investment, run it through that checklist. This will help you avoid making the same mistake again.
Brian’s recommendations
Brian recommends reading books and watching YouTube videos to get all the information you need to make good decisions. Brian also recommends checking out his free investing checklist—the exact investing checklist he uses. The checklist contains both the positive attributes that Brian looks for in a business and the risks he wants to avoid.
No.1 goal for the next 12 months
Brian’s number one goal for the next 12 months is to keep the flywheel that he has going and continue to grow his business.
Parting words
“Learn to love the process of becoming a better investor. If you can actually find joy in the process of becoming a better investor, you’ll actually become one.”
Brian Feroldi
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