The wild ride of Canada's most-watched stock

It's been years since Canadian investors considered Nortel (TSX:NT) to be just another stock. It's attained an almost mythic place in the public consciousness. And it's not hard to see why.

At one point in the not-too-distant past, Nortel alone accounted for more than a third of the value of the entire TSE 300 Composite Index (now known as the S&P/TSX Composite Index). How it got there (and especially how it plunged from that lofty perch) became a matter of national pride, national debate, and eventually national hand-wringing. For many people, the rise and fall of Nortel's stock seemed no less than a judgment on Canada itself.

How did Nortel come to assume such importance? From a stock market perspective, it became a giant through explosive growth as it developed equipment to address the surge in Internet demand in the latter half of the 1990s. Helping to leverage that growth was the company's ambitious strategy of acquiring smaller companies that would help it meet that demand.

Back in 2000, the business media made constant references to "heavily-weighted" Nortel. So just what was it that made this particular stock so "heavy"?

Nortel's reputation as a market heavyweight derived from its influence on such key market indices as the TSE 300 Composite Index (now the S&P/TSX Composite Index). At its "heaviest," Nortel could move Toronto's benchmark index all by itself.

"What about the other stocks in the index?" you ask. Well, they just didn't matter to the same degree. To understand why, you need to look at how the main TSX benchmark is compiled.

To say the S&P/TSX Composite Index tracks the biggest companies listed on the Toronto Stock Exchange tells only part of the story. Unlike the Dow Jones, which is a price-weighted average of 30 stocks, the TSE 300 and the S&P/TSX Composite are float-weighted indices.

That means they take into account the number of shares available for the public to buy, as well as the company's share price. So a huge company like Nortel, which used to have 3.8 billion shares outstanding, wielded an enormous amount of influence on the old TSE 300 index when Nortel was trading at its lofty heights.

How much influence? As of July 26, 2000, when Nortel was trading at $124.50 a share on the TSX, it represented 36.5 per cent of the TSE 300 index; the other 299 companies accounted for the rest. It had a market capitalization (number of shares times stock price) of almost $400 billion.

The higher Nortel's share price went, the greater its weight in the index. And the more the TSE 300 Composite Index rose.

In 1999, for instance, the TSE 300 Composite Index rose by almost 30 per cent, eclipsing the Dow's 25 per cent rise. But take away Nortel and BCE, and the TSE 298 was up only 6.5 per cent.

And when BCE spun off most of its huge stake in Nortel in early 2000, the Nortel effect became even larger.

And since BCE is Canada's most widely-held stock (often called a "widows and orphans" stock because of its regular dividend and perceived safety), hundreds of thousands more suddenly found themselves owners of Nortel shares courtesy of the spin-off.

Here in Canada, the "Nortel effect" has had huge implications for investors and money managers. For one thing, it made it virtually impossible for the manager of a diversified Canadian equity mutual fund to beat the benchmark index when Nortel's stock was galloping ahead.

When Nortel was rising like it did in 1999 and much of 2000, it was very difficult to outperform an index that had a huge exposure to a stock that was beating the pants off everything else.

There's also the flip side, of course. When Nortel falls, the index falls right along with it.

And fall it did. On October 25, 2000, the sky began to crumble. John Roth issued the first in a long series of sales warnings and the stock fell from $96 to $71 in one day. The TSE 300 plunged 840 points that day.

Throughout 2001, with its sales steadily collapsing, Nortel issued a stream of revenue and profit warnings and began a series of wholesale layoffs that saw its 90,000-strong workforce reduced to less than half that. Nortel's stock, which began the year at $46, ended at under $12.

Several sales warnings in 2002 and a downgrade of its long-term debt to "junk" status knocked the once-mighty stock price down to 69 cents by October – less than 1 per cent of where it had been just two years earlier. Where once Nortel had been the biggest company in Canada (by far), it was sitting in 46th spot by the fall of 2002, with a weighting in the S&P/TSX Composite Index of less than one per cent.

In September 2002, the company announced that it would take steps to consolidate its shares to avoid being delisted from the New York Stock Exchange. Under NYSE rules, a listed company's stock risks being removed if it closes below $1 US for 30 consecutive trading days.

But it never had to do that consolidation. More jobs cuts (it was down to 35,000 employees by the spring of 2003) started to pay off on the bottom line. In April 2003, it reported its first quarterly profit in three years ($54 million US). Technology companies, which had stopped spending money in 2000, opened their wallets again. Nortel snagged several high-profile billion-dollar contracts. And the stock price began to revive.

By September 2003, the shares were above $6 – still a far cry from the glory days – but up almost 10-fold since the previous fall.

But just as Nortel seemed to be turning the corner, investors were sideswiped with more bad news. The first inkling came in October 2003, when Nortel said it would have to restate its finances back to 2000. Further announcements revealed that this was no small deal.

In March 2004, two senior finance executives were put on leave. The following month, those execs were fired – along with CEO Frank Dunn – after Nortel revealed that its much-ballyhooed 2003 profit would be slashed in half. An accounting review had turned up "irregularities." The stock sank anew and class action lawyers found themselves with new business.

Regulators on both sides of the border began investigating, and they were soon joined by the RCMP. And while all this was going on, there were more job cuts – another 3,250 got pink slips in September 2004.

As Nortel faced – and missed – one reporting deadline after another, its stock price continued to come under pressure. In May, 2005, after it had finally reported its 2003 and 2004 financial results, it was clear that the company was facing only modest revenue growth and Nortel's management was facing an increasingly competitive marketplace. The shares slipped to $3 – their lowest point in more than two years.

On Dec. 1, 2006, Nortel went ahead with the stock consolidation it had planned but never implemented back in 2002. It chopped the number of shares by 90 per cent — a move that boosted its stock price 10-fold to the $24 range. But by February 2008, the stock was back below $10 ($1 on a pre-consolidation basis) as losses grew and sales fell. By March, the stock had hit an all-time low.

Because so many Canadians own Nortel shares (either directly, through pension plans, or in the hundreds of mutual funds that own a piece of it), it still remains the most actively-watched stock price in Canada. It was Nortel's prominence in the portfolios of Canadian investors that initially drove the praise – and then the criticism – of what was Canada's biggest company. That spotlight is not likely to shift any time soon.