"Enron is the pinnacle of the Internet era, capping the whole thing off," said John Wakeman, vice president of research at fund company T. Rowe Price Group Inc. in Baltimore. "The prevailing attitude was, 'Just tell me the story and never mind the fundamentals.'"
Despite their supposed sophistication, portfolio managers have "a long history of falling for a great story," Wakeman said. "Usually it's a capital-intensive business where the 'sell side' cheerleaders [brokerage analysts] are out in force."
With Enron, the enticing story was about reinventing the energy trading business via the Internet.
Some Insiders Call Criticism Overblown
Wall Street's army of brokerage analysts has long been taken to task for buttering up corporate managements with glowing reports to help generate investment banking business for their firms, rather than honestly critiquing stocks. Money managers--the "buy side"--always have maintained that they aren't duped by analysts. But the Enron tale suggests otherwise.
"What this shows is that investors at all levels need better discipline," Wakeman said.
Still, even diligent scrutiny is unlikely to thwart outright accounting fraud, experts note. "It's difficult even for auditors to detect fraud if management really wants to hide something," Veaco said.
Some fund industry insiders say criticism over their Enron investments has been overblown.
Shelley Peterson, spokeswoman for Denver-based Janus, said her firm sustained "very minimal losses" overall in its Enron holdings, in part because it got in early, first buying shares in January 1999. Janus was a net seller of the stock from March 2001 through mid-November, when it sold its last shares, she said.
Still, its Enron holdings couldn't have helped performance last year, when Janus' diversified domestic stock funds lost an average of 24% on an asset-weighted basis--the worst performance among major fund companies, according to investment firm Kanon Bloch Carre.
But Peterson defended Janus' research, which, she noted, led the firm to buy Enron early, well before there were indications that the company was less than forthright.
"Our research process is strong, but it's predicated on a company not hiding information," she said.
Other funds that had big stakes in Enron last year declined to comment other than to say they have since sold the stock.
Post-Enron, investors of all kinds have grown increasingly skittish, and portfolio managers have become more leery about stock stories, some say.
"The good to come from all this is that as an industry we're becoming much more independent and doing more critical thinking," said Bob Bilkie, portfolio manager at Sigma Investment Counselors in Southfield, Mich., which handles private accounts.
"The Enron disaster means you go through all your portfolios looking for companies whose earnings are less than transparent or whose income statements are so complex you can hardly figure them out," Bilkie said. "You're going to see a lot less blind faith in management going forward."
Firms seen as having complex structures or aggressive accounting, such as the conglomerate Tyco International Ltd., are feeling the effects of a jittery market on their stock prices. Tyco's shares have tumbled 24% this year.
"Whenever there's even a hint of possible obfuscation of financial disclosures, the company is now punished," said Jim Lyon, portfolio manager at investment firm Oakwood Capital Management in Century City.
He and Bilkie both said the market probably has overreacted in the case of Tyco, where no evidence of impropriety has surfaced, and the company has strongly denied that its accounting is aggressive. But "people are going to shoot first and ask questions later. Everybody is in survival mode," Bilkie said.
Need for Greater Diversification
He pointed to biotech giant Amgen Inc.'s release of quarterly earnings last week as an example of a renewed sense of wariness among investment pros. Bilkie said he will analyze the report more closely than he might have six months ago, and he suspects competitors are doing the same.
Amgen said quarterly net income was reduced by a one-time charge of 15 cents a share for unsuccessful drug collaborations.
"I have to question whether that's really a one-time charge or the cost of doing business in that industry," Bilkie said. "Either way, I think it's still a good company with good long-term prospects, but I basically have to figure out my own pro forma earnings for every company."
Lyon said the Enron collapse probably will reinforce the need for greater portfolio diversification by fund managers and retail investors.
Another old-fashioned lesson reinforced by the blowup is that, ultimately, valuations matter. Highly valued stocks, as measured by price-to-earnings ratios and other yardsticks, may deserve to trade at a premium to the market because of a superior business, but those inherent lofty expectations carry downside risk: If the company eventually disappoints, the market might crush the shares.
Reidy said his fund looked at Enron last spring when the stock was at $60 and trading for about 40 times earnings per share, but "we determined that it's basically nothing more than a trading company, and there's nothing stable about that kind of business."
Josh Friedman can be reached at email@example.com.