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SVB's share price collapsed in a single day and shareholders were wiped out, providing a nasty example of the biggest risk in holding an individual stock.Trifonenko/iStockPhoto / Getty Images

If you didn’t own shares in Silicon Valley Bank prior to its failure last week, you dodged a bullet. But can you dodge the next one?

The bank’s share price collapsed in a single day and shareholders were wiped out, providing a nasty example of the biggest risk in holding an individual stock: It can die. Fast.

There were plenty of reasons for the SVB collapse, but they may not have been obvious to the small investor – or any investor for that matter – before the crisis exploded.

SVB was a lender to the venture capital ecosystem, and tech startups have struggled over the past year as the U.S. Federal Reserve raised interest rates in a battle against inflation. This focus on a single sector stands out from more diversified lenders.

The bank also had an odd approach to deposits: It invested the money in long-duration securities, including long-term mortgage-backed securities. When these assets fell in value as the Fed raised interest rates, a wave of problems emerged.

As depositors withdrew money, SVB was forced to sell bonds at a loss to raise cash to meet redemptions. It then tried to issue additional shares to shore up capital. A full-fledged bank run followed, exacerbated by the fact that about 90 per cent of its deposits were uninsured – higher than a US$250,000 maximum for federal deposit insurance. That is a ratio well above that of most other banks – and, well, SVB is now no more.

These red flags may have put off some investors who knew their way around bank balance sheets, were well aware of SVB’s strong connection to the volatile tech sector or were just plain worried about the deteriorating economic climate.

Last year, as interest rates shot higher and technology companies floundered, SVB’s share price declined from about US$733 at the start of 2022 to about US$230 in December. The slide marked a dramatic shift from gains of 75 per cent in 2021, and it meant that a lot of investors were bailing out.

At the same time, short sellers – nimble investors who bet that a stock will decline – became active in SVB. A year ago, in March, the number of shares sold short in comparison with the total share count, was just 1.4 per cent, according to Nasdaq. But this short interest jumped to 6.7 per cent by the end of 2022.

But were any of these actions flashing a warning sign that SVB was heading for failure? Maybe not.

Despite the diminished share price, the collective wisdom of the market valued SVB earlier this month, prior to the collapse, at nearly US$16-billion, based on the value of outstanding shares. The share price actually rallied in January amid bets that the Fed was nearly finished raising rates.

There was also SVB’s impressive track record to consider.

It had been around for decades, surviving the bursting of the tech-stock bubble in 2000 and the 2008 financial crisis. And it had found a niche among startups and tech entrepreneurs that delivered enviable deposit growth when times were good.

“When others left the Valley in 2001/2002, SVB was the bedrock and played an instrumental role in the thousands of successful tech startups seen over the years,” Dan Ives, an analyst at Wedbush Securities, said in a note.

There were plenty of signals, then, tempting investors who like to buy stocks when they are cheap and unpopular, hoping for a big rebound. But that’s what makes SVB, and stocks like it, so dangerous.

The best lesson here for risk-conscious investors: Focus primarily on baskets of stocks that spread out the risk of any one of them blowing up. Yes, you’ll likely be saddled with a lot of underperformers, but they probably won’t harm your portfolio in any meaningful way, and you’ll get the winners too.

We live in a golden age in which exchange-traded funds offer exposure to just about any sector, strategy or index you can think of – from value stocks, growth stocks, banks and real estate investment trusts all the way up to emerging markets, developed markets and the S&P 500 Index.

If small banks are your thing, there’s even the iShares U.S. Regional Banks ETF, for example. It’s not doing well this year, but it’s no SVB.

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