One of the reasons I love investing is that
it is not just a battle against other intelligent, knowledgeable and committed
people but a battle against yourself. Each of us have biases that prevent us
from acting optimally and it is by knowing ourselves better and designing
strategies to overcome these biases that we become better investors. It is in
this spirit I offer, not a celebration of the 2015 successes or tips for 2016,
but some of the mistakes I made this year:
Not
being bold enough when the downside was negligible
On 12th August a company called
Pure Wafer announced that they would return 140-145p to shareholders from an
insurance payout related to a fire in the UK part of their business. The shares
opened that day at 145p to buy, presumably due to generally poor market
sentiment in August 2015. Given that the company still retained a profitable US
trading business then it was highly unlikely the shares would be worth less
than 145p. I used all of the spare cash in my dealing account to purchase
shares and then turned to my spread betting account. However at this point I
was not bold enough. Given that the downside was negligible I should have used all
available margin to open a position however I was too cautious and only added a
small amount. The shares rapidly rose to 165p that day as others realised the
opportunity and following the sale of the trading business should return 188p
in total to investors. The market rarely offers a free lunch but when it does
you need to absolutely stuff yourself.
Thinking
that buying the best companies in an industry with bad economics would protect the
downside
One of the biggest investment themes of
2015 has been the rout of commodity prices and the impact on commodity producers.
Although I’ve never liked commodity exposure as investment theme in itself there
are certain attractions to owing oil companies. Their assets are easily
analysed and assets that will be drilled or developed far in the future are often
neglected in valuations giving opportunity to those with longer term investment horizons. As
a contrarian investor I wanted exposure to the sector but to limit the downside
should there be no medium term oil price recovery. Therefore I added shares like Ophir
& Bowleven that had strategic assets and large cash holdings. Despite
paying historically low prices and below cash in the case of Bowleven that didn’t
stop prices falling as the oil price fell further. When a sector is seriously
out of favour then everything gets sold. This maybe illogical and may be a good
contrarian buy going forwards but the strategy of buying the cash rich oil
companies didn’t in reality protect the downside in 2015.
Being
too worried about the spread
The commodities rout has had a knock on
impact into the oil services sector leaving a number of companies looking very
cheap, at least on historic metrics. I’m always interested in extremely sold
off shares and unlike oil exploration and production companies the service
companies often have other subsidiaries unaffected by the oil price collapse.
Two such companies that are on my watch list are Northbridge Industrial and
Pressure Technologies. In both cases I was very close to buying, Northbridge quoted
at 66p and Pressure Technologies quoted at 147p. In both cases I rejected the
quote because I didn’t want to pay the full ask. Prices now are 89p for Northbridge
and 192p for Pressure following trading statements or results that were not
great but simply not as bad as the market feared. Sometimes it pays to pay up, especially
when prices are already significantly depressed.
Failing
to exit an investment going wrong quickly
On 17th March defence training specialist
Pennant International reported their FY results. Although on the surface they
seemed to be fairly positive a detailed reading of the figures suggested that
they were struggling in a number of areas and were overly reliant on a few
contracts. Since I was slow to do the full analysis the price had dropped from
98p to c.80p by the time that I had realised that things were not as rosy as
they initially appeared and due (presumably to loss aversion) I didn’t sell.
Today Pennant trades at 40p.
Exiting
promotional shorts too soon
Nothing goes up 4-5x in a couple of months
without significant amounts of ‘hot money’ being involved. Therefore when you
see these sort of rises in story stocks they can make very good shorts.
Particularly where there is some kind of share overhang on its way (e.g. a
lockup period for a major holder ending) which will apply pressure to reverse
the flow of hot money. The area that I have found most lucrative is companies
that have entered into an equity swap financing deal like Amur Minerals or AFC
Energy. These deals see the company raising funds by issuing shares to a
company like Lanstead Capital but using that cash to enter into a swap
agreement with Lanstead whereby the cash payment they receive each month depends
on the share price. This leads to a strange mix of incentives. The management want
the share price as high as possible but once it has risen the swap provider wants
to sell as many shares as possible to fund their payments to the company and
reduce the amount that they pay. Hence the spike up and the slow decline:
Amur Minerals
So what’s the mistake? In both cases having
got good entry points (40p for Amur Minerals & 54p for AFC Energy) I closed
the shorts far too soon (27p for Amur & 33p for AFC.) What went wrong was I
started to fear the promote would push the shares higher and failed to believe
my own analysis that said that the share overhang of the equity swap provider exiting
would push the shares much lower and reverse the flow of hot money. Amur currently
trades at 8p and AFC at 24p. It’s annoying to get the analysis right but not
fully capture the resulting move.
Underestimating how foolish takeover buyers can be
In March 2015 the Australian law firm Slater & Gordon paid £640m for the legal services part of Quindell a company of which I was short. My analysis had shown that there were significant issues with the quality of Quindell's business and that without Slater & Gordon's intervention the group was likely to run out of cash. It seemed completely illogical that S&G would pay a significant premium of £640m for a business that was close to bankruptcy particularly since it would require significant debt and equity raise by S&G to fund it. As it turns out that my analysis was probably correct and Slater & Gordon have subsequent lost almost 90% of their value since the deal. What I got wrong was probably not the analysis but dismissing quite well sourced rumours that a deal had been done and then closing the short when the deal was announced. The rest of the Quindell business was of such poor quality that if I'd simply rode out the intitial deal spike I still would have made money on the short.
I’m sure I’ll make many more mistakes next
year and despite these this year I made enough good decisions to generate an ok
return. My aim however is not to repeat these particular ones.
Wishing you all a Happy Christmas! And may
you only make new mistakes in 2016 too.
