Ninety One: What goes up...

4 April 2019  Author: Alastair MundyPortfolio Manager

Many years ago, I played cricket with an old boy (well he seemed like an old boy then, I now realise he was younger than I am today) who had a batting technique that was less than pleasing on the eye. The young guns in the team were happy to ridicule Alan, whose riposte was unfailingly consistent: “look in the scorebook”.

And he was right. While he scratched around, playing several shots unlikely to be granted inclusion in the MCC coaching manual, his system worked, and year after year he outscored (and outdrank) most of his more elegant teammates.

I was thinking of Alan as I read Tim Steer’s new book, ‘The Signs Were There – The clues for investors that a company is heading for a fall’. Mr Steer walks the reader through 22 companies which unwound at pace and illustrates how a reasonably quick study of the report and accounts of each would, at the minimum, have raised a number of red flags. The examples take the reader through the usual issues – revenue recognition (the company being overly optimistic when booking sales), related transactions, capitalisation of costs (i.e. magically turning costs into assets), dubious acquisitions and so on.

While the post-mortems are interesting and well explained, what caught my eye was how well most of the shares had performed prior to their denouement. These were, in general, stocks which had caught investors’ imaginations in the good times.

For example:

• Connaught rose more than 8x before falling steeply to its death within 12 months.
• Utilitywise rose more than 6x in the two years prior to its peak and has recently been suspended after a five-year, 99% fall.
• Conviviality doubled to its peak in less than two years and then went bust less than six months later.
• Healthcare Locums quintupled over a three-year period and lost 98% of its value in the subsequent two years.
• Erinaceous more than trebled in less than two years and was gone within two years of its peak.

What conclusions can we draw from this other than wondering what current high flyers may not be with us two years hence? Well, I assume that Mr Steer’s red flags were probably flying well before shares peaked. However, even if some investors were aware of these issues and acted on them, their prescience was eventually overcome by investors reacting to earnings upgrades and share price strength.

This illustrates what is often very clear:

i) momentum is a very powerful factor and ii) can turn on a sixpence, often times even more precipitously in the opposite direction.

These case studies also suggest that only a minority of investors read or care about a company’s accounts, which must be music to the ears of a fundamental investor. However, a momentum-ista would probably point out what a fundamentalist ‘could have won’.

And this is what made me think of Alan – an investor could have apparently bought into the momentum of each of those stocks and made very healthy profits…and then told the rest of us to look in the book.

That approach probably has worked well at times over the years, but it does rest on the assumption that liquidity is ever present – a generous assumption at the best of times, but one tested most rigorously when most of a company’s shares are in the hands of similarly minded investors.

I have never represented the evangelical wing/lunatic fringe of value investing and consequently accept that there are many ways that investors make money. However, with markets edging back to their highs post a fourth-quarter scare it is worth highlighting the risks of holding stocks which many of one’s peers hold. Value investors have a habit of declaring their innings too early, other styles bat on in the hope of a much higher score.

No representation is being made that any investment will or is likely to achieve profits or losses similar to those achieved in the past, or that significant losses will be avoided.

Alastair Mundy

Portfolio Manager

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