Okay, so this isn’t actually my worst investment ever (I managed to invest in Yellow Pages provider Yell before it went bust in 2013), but it’s pretty close.
The company in question is called Xaar.
It’s a small-cap “disruptive” technology company, and that immediately puts it somewhat outside my usual hunting ground of long-established FTSE 350 dividend payers.
Since I invested in 2018, Xaar has had an existential crisis which resulted in the dividend being suspended and its shares are currently down by about 85% from where I bought them.
This is not good and several years ago I would have sold the company almost as soon as it suspended its dividend.
However, I think that’s an overly simplistic knee-jerk reaction, and that’s something I generally try to avoid.
That’s why, rather than sell immediately, I decided to spend a fair bit of time re-reviewing Xaar from the ground up. I wanted to know: 1) how much of this loss was down to bad luck, 2) how much was down to a bad investment process and 3) how much was down to a bad analyst (i.e. me).
You can read about my Xaar blunder, what I’ve done to fix the root causes and what I intend to do with the shares in a recent article I wrote for Master Investor magazine ( linked below).
In summary though, it’s a bit of all three.
1) Bad luck
I think management effectively drove Xaar off a cliff, and I don’t think it was obvious that they were going to do that beforehand.
2) Bad process
There were definitely some flaws in my process, which I have tried to plug with an updated version of my Company Review Checklist (available on the free resources page).
One problem with the old checklist was that with so many points, it was easy to loose sight of my simple, high level goals.
So the updated checklist includes a clearer focus on my fundamental goal, which is to manage a diversified portfolio of above average (dividend paying) companies purchased and held at below average prices.
3) Bad analyst
Being able to admit to mistakes is vital if you’re to improve as an investor (or anything else for that matter). In this case, I was overly optimistic and had too much of a positive mindset, looking for reasons to invest which just leads to confirmation bias.
Xaar’s track record had some specific problems (which I cover in the article below) and I wasn’t sufficiently critical of them.
To fix this, in future I will try to be the Abominable No-Man, ruthlessly saying NO to any company that does not meet and exceed my criteria.
“Warren Buffett calls Charlie ‘The Abominable No-Man’ since his answer on a given investment is so often ‘no'”
25iq – Charlie Munger on mistakes
Fortunately I at least followed my rules about diversification, and only invested about 4.5% of my model portfolio in Xaar at the outset (and a similar amount in my personal portfolio).
I deliberately keep individual investments to less than 6% (typically starting positions at around 3% to 4%) because that’s the level of company specific risk I can accept without losing any sleep.
If I had 10% in Xaar and it went bust, my wife would probably throw me out of a window (hopefully on the ground floor).
My worst investment ever
(or, what to do when a company suspends its dividend)
P.S. The title for this blog post comes from a podcast called My Worst Investment Ever.
P.P.S. Long-time readers may have spotted that 2019 appears to be something of an Annus Horriblis for my model portfolio. After all, I:
- sold Centrica in March for a 36% loss over six and a half years
- sold Vodafone in July for a measly 44% gain over eight years
- sold SSE in September for a tiny 34% gain, also over eight years
- sold The Restaurant Group for a 38% loss over three and a half years
Now I’m talking about Xaar being down 85% and I’ve also written about Mitie, another of my holdings which is significantly underwater.
Obviously, these are not the kind of results that any investor wants to see, but it’s important to focus on the forest rather than the individual trees.
In my case, selling Centrica, Vodafone, SSE and The Restaurant Group has been part of a “spring cleaning” effort to remove some old investments which I’d bought a few years ago, before I started to focus on companies with above-average levels of profitability (especially once lease liabilities are taken into account).
Xaar was a mistake, plain and simple, and Mitie has become a turnaround which has yet to reach its conclusion.
Looking at the entire portfolio, I feel reasonably confident that it’s made up of a diverse group of companies that are (mostly) of above-average quality and are (mostly) trading at below-average prices.
In terms of performance, the portfolio has gained about 11% year-to-date and is just 6% below the all-time high it reached in mid-2018. It’s also on track to produce another record year of dividends.
So while there have been some disappointing investments this year, caused by a mixture of bad luck, bad process and bad analysis, I don’t think the fundamentals of my investment strategy are broken and I don’t think now is the time to throw in the towel and go passive.
On the contrary, I think bad investment outcomes and bad investment decisions (which are not necessarily the same thing) should be used as an opportunity to improve your investment process and to sharpen your knowledge and skill as an investor.
What they can’t do, unfortunately, is improve your luck, but that just underlines the central importance of broad diversification, which was never in question anyway.
Hi John,
My biggest mistake so far is AA Plc.
The mistake was mine entirely I had limited understanding on the concept of moats, what makes good management and poor grasp of finance. At that time I also had a trader mentality trying to find one good idea per month.
I think I learnt a lot from my mistake.
Hi Reg
Thanks for sharing your Worst Investment Ever. I think talking about bad investments is good practice because it help you stay humble and stops the ego getting out of control.
As for AA, I think it’s the sort of company that sucks a lot of people in because it’s such a well known brand. But a brand name is not a moat, as Thomas Cook and many others have found out.
Still, as long as you learn from the experience the net outcome can still be positive, and hopefully your position size was sensible (i.e. small!)
Hi John,
On reflection the company itself wasn’t bad rather a combination of a very bad capital structure i.e. leverage nearly 10x net income, lack of investment over time leading to significant need of investment, poor management. My position was extremely small so I’m not really that stressed with the poor result.
This led a shift in my strategy focusing on the 800lb gorilla companies instead. You’re right about the brand being a sucker for being misidentified as a moat. I think it helped me realise the real long lasting moat of a company is scale of economy.
If a company has a dominant market share, relatively straightforward capital allocation requirements and is backed by scale of economy then in theory it can have high level of debt (like tobacco companies) and poor management (like Steve Ballmer of Microsoft) but still gush out cash and survive a bad stewardship.
One limitation of my strategy is the need to hold a concentrated position because its extremely rare to get the 800lb gorilla on the cheap side of valuation. I use a similar check list to Terry Smith and have only about 30 odd companies I would consider investing in but these would be indefinite.
PS This feels like Investors Anonymous
Investors Anonymous would be a brilliant name for a website or blog! After all the most efficient way to learn is by learning from the mistakes (and occasional successes) of others, which is kind of the point of this blog post (and possibly this entire website).
As for market share being a strong indicator of ‘quality’, I have drifted in that direction too. Although I don’t have a hard and fast rule, I now much prefer to invest in market leaders rather than companies which are just one of many competitors.
The combination of scale, brand and reputation can be very powerful at attracting talented employees and loyal customers, whilst allowing cost efficient operations, sizeable funds for R&D, sharing of best practice, etc.
The trick is to avoid complexity and bloated bureaucracy. In other words, market leaders that operate a narrow, highly focused business.
Is AA a bad company?
It has too much debt for the UKValueInvestor portfolio.
However, at the current price it could belong in other value portfolios.
I sympathise with anyone who rode it from 400 down to 40.
However:
* gross margin 60%
* operating margin 26%
* dividend yield 4.3% (cover 7.2)
* interest cover 1.3
* long term debt high but decreasing
An idea I am exploring is whether a moat can be detected quantitatively using ‘profit margin’. Specifically, I mean the ratios like operating profit or FCFf to turnover.
My theory is that competition erode profit margin (e.g. Sainsbury’s).
Does a consistently high profit margin (of FCF margin) reveal a lack of competition and strong pricing power?
e.g. Rightmove
Hi Ken
To be honest I haven’t looked at AA in detail at all. It only listed on the stock exchange in 2014, so it’s too new for me (i.e. not enough financial track record to review).
As for its quality, it’s hard to say because the company has a mountain of debt. If you took Microsoft and loaded it up with enough debt it would probably go bust, so the quality of the company becomes immaterial if debts are way too high.
Profit margins: These are impacted by competition, of course, but they’re also largely a function of business type. So a software company might have huge margins because the marginal cost of goods sold (i.e. the cost to provide software to someone via email or whatever) is almost zero, so margins are huge. But if you sell food, like Sainsbury’s, then the cost to make another loaf of bread will make up the majority of the price of that bread, so margins are wafer thin.
Although I do take account of profit margins, I think returns on capital employed is the fundamental measure of profitability and competitive strength, because it represents the capital used by the business to generate profits. If a company can produce 20% returns on capital then that will attract competition, and if a company can produce 20% returns on capital for decades then it must have some sort of moat to protect it from competition, otherwise its returns would have been reduced to something much closer to average (say 5% to 10%).
If you look at Rightmove (a software company, effectively) then its margins and returns on capital are incredibly high, and consistently so, so it clearly has a massive moat, which is the network of buyers and sellers that use its website.
John it seems to me that the AA is hounded by competition and the debt seemingly seals its fate.
Greenflag
RAC
Emergency Assist
GE Motoring Assist
Eversure
Insure4 Breakdown
AutoAid
Gem Motoring Assist
LV Britannia Rescue
Start Rescue
National Breakdown
+Many Many More
Looks like a road to nowhere and a car crash waiting to happen on margins if you can forgive the puns.
LR
I used to use the AA, but cars now are insanely reliable (10+yrs since I had any problem with a car other than a puncture) so I decided to take my chances and sign up with them on the day my car breaks down!
Hello John,
Any chance of the second version of the “THE DEFENSIVE VALUE INVESTOR” coming soon?
Regards,
Pradeep
Hi Pradeep, yes I’m working on the second edition. I think it will probably be ready for Christmas 2020. It will also probably be available as a free weekly email course, in something like 20 instalments.
Well That is good to hear.
Will be waiting for it.
John, you are lucky you have a wife who is capable of throwing you out of ANY window: I have the opposite, one who doesn’t like shares, thinks they are unsafe, but lets me do what i want, which is a dangerous combination as I often feel guilty when we get a windfall and want to invest it in the portfolio. With that in mind, when we had a bond mature at £9600 I decided to ‘play safe’ by her and invest in a fund. The fund was Woodford’s, luckily sometime before it failed but in time to instantly reduce my cash by £800. I waited some months for encouraging news then, remembering your brave actions of 2011, I bit the bullet and withdrew the £8600, putting £4000 of it into a share – Scottish Widows investment trust. Within three months it gained £1000 to my delight, with the rest going to the portfolio for future use.
The moral is, of course, trust yourself AND do the sums: my wife has the best will in the world but reacts in fear to hearsay, while I reacted in guilt instead of diligent belief. Lesson learned.
Hi James, perhaps true love is when your wife/husband/etc cares enough to throw you out of a window if you do something daft?
More seriously, I think another key lesson is diversification. I watched the Panorama program about Woodford, which was actually quite good and only slightly sensationalist:
https://www.bbc.co.uk/programmes/m0009mvp
It was sad to see people who had lost huge lumps of their retirement assets by investing largely or entirely in Woodford’s funds.
I think that unless someone is invested in a global tracker (stocks, bonds, whatever) then they shouldn’t have 100% of their money in anything (perhaps other than cash if that’s what they want).
I made that mistake when I was 100% invested in the FTSE All-Share back in the 1990s. It went up a lot and then crashed in 2000-2003, and I sold out when it was nearly 50% down. It was a mistake that many people made.
If I’d had 100% in a global tracker (not sure they existed back then), or 20% in UK, US, EU, Japan, Asia, bonds, then the decline would probably have been smaller and perhaps I wouldn’t have sold out with such losses.
So I think diversification is always the first lesson, and then everything else comes after that.
I read this last year ..”To me that looks like a very attractive proposition, and if I can get over my dislike of large pension schemes then I would be willing to invest in Connect Group, probably at anything under 100p.”
https://www.ukvalueinvestor.com/2018/03/connect-group-dividend-yield.html/
And after doing my own research, I invested a small % of my cash float at around 50p. A distribution deal failed to deliver, the dividend was cut to zero and the shares lost 40%. I bailed for a loss and as of today the share price is 28p.
My worst investment (in terms of % loss, absolute loss would be LLOY, but that recovered). Lesson learned, diversify and treat individual share tips with extreme caution.
These days I’m mainly in funds, FUQUIT for capital and Regional REIT (RGL) for income.
I see you don’t seem to have followed your own advice, well done for dodging that bullet!
Hi Philip
Thanks for highlighting this one. I might do a blog post to revisit the company and discuss why I didn’t invest. I can’t remember the exact reason offhand, but I know that I wouldn’t invest in Connect Group now (even as it was back in 2018) because I’m now more wary of company’s operating in a declining industry, and delivering newspapers is definitely a declining industry. If I’ve already done a write up somewhere I’ll link to it in another comment, otherwise I’ll do a blog post.
John
John, I’m curious about the omission of Ted Baker from the Annus Horriblis list. Surely it is noteworthy?
Hi Ken
To be honest Ted Baker slipped my mind, but that’s because I don’t really consider Ted Baker a ‘bad’ investment yet.
I don’t think it’s clear, yet, whether its bad interim results were a blip or a sign of a deep and incurable cancer. There are reasonable reasons for its unexpected half year loss, and management certainly seemed to think it was business as usual, albeit in a difficult trading environment. So I’m currently awaiting further info, primarily its next annual results.
John, I apologise for asking frequently about Ted Baker but it is fascinating to me because, as you say, we must “await further info”. The lesson is yet to be learned and is being revealed slowly. I don’t want to miss this valuable lesson.
The consensus opinion is quite clear – the price of TED has dropped from 35 to 4.
The data on SharePad is not so gloomy. There is no catastrophe. Maybe the market has overreacted, but disagree with the market at your own peril!
The article on FCF was excellent and I adjusted my view of TED and sold my shares. I didn’t replace TED with IMB, but I did buy BATS.
FCF is king and TED’s FCF yield has improved and is attractive at TTM FCFf 12% and FCFe 33%. Unlike Xaar, the CapEx has decreased between 2016 and 2020 from £89m to £28m.
Maybe that’s the lesson:when revenue stumbles, cut back CapEx to boost FCF and calm the market.
TED now ranks 7 on the list of 275 FTSE small caps, by FCFe yield.
I’m learning what else to consider. For example, TED’s Piotroski score has declined, between 2015 and 2020, from 6 to 3 (maximum 9). I am studying each of the measures that Piotroski considered predictive.
In terms of free cash flow, my opinion is that Ted’s FCF weakness is due to the combination of rapid growth and weak returns on capital employed.
In other words, the company has basically tripled in size over the last ten years. That takes a lot of investment in stores; about £150m above maintenance capex for a company earning an average of £35m a year.
So huge waves of cash have had to go into the expansion, warehouses, stores etc, and Ted Baker stores are not exactly Aldis. They’re extravagant things which probably cost a fortune to fit out.
FCF weakness can be fixed, I think, by halting growth for a while. That might even be a good idea from an operational point of view, i.e. let the company catch up with itself, let its new stores, staff, warehouses, IT systems etc have a chance to settle in and be optimised, before pushing ahead for more growth.
Not sure management will want to do that though, but I think it might be a good idea. And some of that free cash could be used to pay down debt, which is a bit on the high side, I think.
Two of my worst:
FGP: Still don’t understand how you can screw up so badly in such a basic cash cow industry. I thought the Greyhound acquisition was a great idea. I believe it boils down to management. FGP has one of the most incapable management teams in the FTSE.
PFG: Copycated Woodford. Nuff said.
Hi Freddie,
FirstGroup: Public transport can be very tricky. It’s very commoditised and rail can mean huge contracts, which are always risky. Not an area I have any great affection for.
Provident Financial: I don’t really know much about this one, although I do have some exposure to the ‘non prime’ lending market. Seems like another one of Woodford’s contrarian bets gone wrong.
As I’ve said in other comments, hopefully your position size was sensibly small (i.e. just a few percent in each).
” importantly, I have changed my mindset from one which was (unintentionally) looking for reasons to buy a company to one that is now focused on looking for reasons not”
John – don’t beat yourself up unduly, remember the rule of five :
1 – investment will disappoint
3 – will perform so so
1 – will pleasantly astound
The more that co accounts trauma history is studied, the more it becomes apparent, that many traps deliberate or accidental lie in the investor’s path.
When reviewing co narratives and accounts, there is generally found a mix of good points and bad points.
The only real answer is to reach a balanced judgement and then diversify, diversify, diversify
Oh, and diversify.
Much as you already do.
Trying to find the perfect unblemished stock is a high hurdle. and good luck with that one.
Hi Bob
I completely agree. Bad outcomes can arise even if you invest in the best company in the world, due to impossible to foresee events. So I’m definitely not looking for some sort of magical unicorn.
I guess I should caveat my statement about looking for reasons not to buy a company because it’s easy to come up with 100 speculative or emotional reasons not to buy anything, even companies like Microsoft, Google, Apple, Coca-Cola, etc. Specifically, I mean that after run a company through my investment checklist, if something doesn’t look right, or fell right (this is deliberately ambiguous), then I will assume the worst, rather than assume the best.
For example, with Xaar, I knew it’s bumper profits of the last decade had come from a one-time boom in the ceramic tile market. But, because my (subconscious) mindset was that I wanted to buy the company, I decided there was a reasonable chance it might repeat that feat in the next decade.
That was bad thinking based on a subconscious desire to buy the company. If my mindset is that I don’t have to buy the company, and that the company has to prove to me that it is worthy of being in my portfolio, then I’m much more likely to take a critical view of any significant variance between what I want and what the company appears to offer.
In Xaar’s case, I should have assumed that the company wouldn’t repeat those bumper profits because there was no evidence that it would.
But your point it still a good one and I do try not to be too restrictive, otherwise you either end up with nothing to invest in or you only buy the best of the best companies, which leaves you open to valuation risk.
My worst investment yet has to be my girlfriend. High Price to Earnings ratio, crippling maintenance Capex, low ROCE, poor management skills. Really don’t know why I bother with such a high risk investment. Well I do actually.
No comment!
You cannot get worse than a wipeout, and I’ve had two of those so far. I guess there will always be bad investments.
Carillion, I thought there would be some type of bailout. I was wrong on that.
Flybe was more annoying as there was ample time to sell this for profit and I didn’t. I still feel as it would have been more valuable to shareholders to break up the company rather than to sell for 1p a share.
Hi Simon
Yes, a 100% loss certainly gets your attention. I remember back in 2007, my very first “value” investment was a Scottish construction aggregate business (selling rocks, basically) which was on a ridiculously low PE or PB, so I bought it and of course it went bust shortly after.
That was my “welcome to value investing” moment.
Hello John, confession time. Over the past several decades I’ve had more than my share of ‘wipeouts’.. British & Commonwealth in the 1980s (basically a crooked manager), Marconi (an ex Investment Banker who went on a deal craze and destroyed Lord Weinstock’s baby) and – I still relive the nightmare and start twitching a la Johnny English every time I think about it – HMV, which went bust and took 36% of my portfolio with it in 2011 (I know,, I know…).
Fortunately, I sold a flat in India (not out of necessity) which replaced the HMV loss, and gradually put the money back in 2015/2016 and the Portfolio doubled in 2016. (Three good calls – the Mining sector, cashing 40% out on Referendum day, while holding on the Dollar earners, and getting back into domestics the following Monday, and holding my nerve when the pundits predicted a fall on Trump’s election).
Needless to say my daughters’ ISA and SIPP Portfolios (which I manage for them) are in well diversified Index trackers!
Thanks for that excellent story Murari.. Good to see that you keep your high risk trading activities to your own account and not your childrens’ (I’m the same; my son’s JISA is in a Vanguard global stock/bond tracker).
As for HMV, I’m tempted to say you should have seen that coming a mile off, but then again I invested about 10% of my portfolio in Yell (Yellow Pages) just before it went bust, so what do I know?!?
Yes John… I should have seen H (twitch) M (twitch) V (twitch) coming a mile off. But hey, even the best Fund Managers… there was this Superstar American Value Manager – stellar returns, appeared on Counsuelo Mack etc. He went all in to Sears as it headed remorselessly downwards. Until he had to fold up his Fund with huge losses. So we are in ‘elite’ company.
Hi John,
I am new to share investing. Just a quick question,
if XAAR was not a good company to be investing in, why has it a comparatively high ranking (number 12 at the moment) on the stock holding screen?
Hi Yee, good question. Companies are complex entities with thousands if not millions of moving parts; products, employees, factories, R&D departments, growth rates, profitability ratios and so on. Much of this can be captured by crunching the numbers, but most of it can’t.
So the purpose of a stock screen is to filter out companies which obviously aren’t what we’re looking for, such as companies that are shrinking, or have huge amounts of debt or are unprofitable or weakly profitable. This makes it much easier to focus on a smaller number of companies that do fit the criteria we’re looking for, i.e. companies that are growing, have good profitability, low debts and so on.
However, even if a company has those features that isn’t necessarily the whole story. There can be all sorts of other problems which the numbers don’t highlight, and that’s why I like to carry out a detailed analysis of the business and its market, which goes far beyond just simple number crunching.
For example, one of Xaar’s problems was that it over-invested in a breakthrough technology which it hoped would drive rapid growth over the next decade. But the amount of investment in R&D caused the company to under-invest in its core products, and so its reputation in the market was that its products were outdated. Another problem was that Xaar decided to sell its printheads directly to end users, thereby removing a lucrative revenue stream from its printer manufacturer customers (printer manufacturers typically like to have a monopoly on printheads that fit their printers, a bit like Gillette having a monopoly on blades that fit its shavers). This caused printer manufacturers to partner with other printhead manufacturers, leaving Xaar unable to get its printheads into newly developed printers.
These strategic errors just don’t show up in a stock screen, so you have to remember that screening for stocks is just the first step. Using a stock screen is like panning for gold. You’re more likely to find gold in the pan that if you just look in the stream, but you still have to swill the pan around and look at each shiny thing you find in detail, otherwise you’re likely to end up with a pocket full of fools gold.