Why I'm Throwing This Once-Promising Stock in the Trash

Today, Fools, is a sad day for me. About two years ago, I came upon a product that I believed in (and still do) and thought could be the next multibagger in many an investor's portfolio.

Alas, it's time to part ways with that company and its combined 50% loss in my portfolio. I'm throwing Rosetta Stone (NYS: RST) in the trash.

A great product isn't enough
Just before my wife and I moved to Costa Rica for six months, we bought Rosetta Stone's Version 4 Totale for Latin American Spanish. We were fully impressed by the software and, as former teachers, with the possibilities the company could have in the education world -- no to mention abroad.

But then, C-level executives started leaving the company in droves, and earnings results were far short of what was expected. Loyal to a fault, I voiced my concerns but kept the faith. Recently, I even called the stock a "terrible" one but said I was still holding. I thought the folks in management were squandering an excellent product. They've been extremely slow in moving from DVDs to a cloud-based system, and I highly doubt that they know how to effectively sell their products to K-12 schools.

Then came this week's news that CEO Tom Adams was stepping down and moving to chairman of the board.

The revolving door at Rosetta Stone is troubling, but that's not what got me to finally pull the trigger. It's pretty clear that management at this company is struggling to figure out ways to monetize the excellent product it has on its hands. This team needs someone who truly understands the value proposition Rosetta Stone offers and can see how it fits within the larger electronic-language-learning ecosystem.

So when I read that Adams had no successor in mind, and that the company would be hiring "Champion Scott Partners, an executive search firm, to actively conduct a search for a new CEO," I'd had enough.

A lesson learned
Though I've heard it a thousand times from other Fools, this underscores just how important management is, especially in up-and-coming companies. As if I need any more reinforcement, just look at how quickly Netflix's (NAS: NFLX) stock has been dinged, largely because of management's inability to communicate its intentions with customers.

Taking a cue from this cautionary tale, I went back and looked at my portfolio. Not surprisingly, all of my biggest winners are (and were) led by CEOs who are also founders who "get" their businesses, are paid modestly for what they do, and have a vested interest in maximizing shareholder value.

Take a look at some of the characteristics that the founders of my four biggest winners share.

Company

Founder and Current Position

Yearly Salary

Approximate Value of Stock Owned in Company

Amazon.com (NAS: AMZN) Jeff Bezos, CEO $81, 840*  $21 billion
Whole Foods Market (NAS: WFM) John Mackey, co-CEO $1**  $81 million
Apple (NAS: AAPL) (The late) Steve Jobs, former CEO $1  $2.3 billion***
Lululemon athletica (NAS: LULU) Chip Wilso, chairman of the board, C-level executive  $289,484****  $2.4 billion

Source: SEC filings.
*Does not include $1.6 million provided for security purposes.
**Does not include $45,968 in non-equity compensation for 2010.
 ***Owned through a trust.
****Does not include non-equity compensation of $331,465.

All those numbers and asterisks may be a little dizzying, but the takeaway is clear:

  1. As founders of these companies, these leaders understand their product, are intimately aware of what makes them "great," and are psychologically invested in their company's success.
  2. They have a considerable financial stake in their company, and that stake is aligned with shareholders' stakes as well.

It's not surprising, then, that over the past two years, $1,000 split evenly among these four companies would now be worth more than $3,000. That's an average 200% return, whereas a similar investment in the S&P 500 would now be worth just $1,130 -- a measly 13% return.

So it's for all these reasons that when the Fool's disclosure policy allows me to do so, two trading days after this article's publication, I will be selling my stake in Rosetta stone.

Where should I put my money now?
The fun part about this disappointing experience with Rosetta Stone is that I now get to look for places to invest the money I have left. With an eye toward leadership that "gets" its product, I'm considering a company -- currently headed by its founder -- that's the subject of The Motley Fool's newest special free report: "One Stock to Own Before Nat Gas Act 2011 Becomes Law." This special video report details a company that could explode when a congressional announcement is made regarding this law -- and that could happen any day now. Get access to this free video today, before it's too late!

At the time this article was published Fool contributor Brian Stoffel will be selling his shares of Rosetta Stone next week, when the Fool's trading rules allow for it. He owns shares of Apple, Whole Foods, Amazon.com, and lululemon atheltica as well. You can follow him on Twitter at @TMFStoffel.The Motley Fool owns shares of Rosetta Stone, lululemon athletica, Apple, and Whole Foods Market. Motley Fool newsletter services have recommended buying shares of Rosetta Stone, lululemon athletica, Amazon.com, Whole Foods Market, and Apple, and creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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