Rudi’s View: Lessons I Learned

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            [0] => ((BAP))
            [1] => ((COH))
            [2] => ((CSL))
            [3] => ((DMP))
            [4] => ((IEL))
            [5] => ((GMG))
            [6] => ((MQG))
            [7] => ((TNE))
            [8] => ((HLS))
            [9] => ((ING))
        )

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            [0] => BAP
            [1] => COH
            [2] => CSL
            [3] => DMP
            [4] => IEL
            [5] => GMG
            [6] => MQG
            [7] => TNE
            [8] => HLS
            [9] => ING
        )

)

This story features BAPCOR LIMITED, and other companies.
For more info SHARE ANALYSIS: BAP
The company is included in ASX300 and ALL-ORDS

After my presentation and Q&A in Toowoomba, Queensland yesterday (having endured the teasing prior to the State of Origin later on the day) I sat down with a few of the local investors to talk investing and markets in a more informal setting.

By Rudi Filapek-Vandyck, Editor

It didn’t take long for the conversation to shift to stocks like Bapcor ((BAP)), Cochlear ((COH)), CSL ((CSL)), Domino’s Pizza ((DMP)), and IDP Education ((IEL)) – all have kept trending to ever lower share price levels over the years past.

While doing so, all have wrongfooted investors who bought in at what seemed “cheaply priced” stocks.

The first observation to make is, of course, that what looks “cheap” can still become a whole lot cheap-er.

There’s probably not a single reader who would dispute each of the companies mentioned has provided the market with plenty of reasons to keep paring back the share price.

Repeated profit warnings are but one angle to take.

But as most profit warnings tend to come out of the blue, the question asked was: how does one decide whether a cheaper share price is truly a bargain or the exact opposite, a value trap?

It’s always easier with hindsight but I do think there’s an uncomplicated and straightforward rule investors can apply – one I highlighted earlier this year before Cochlear and Bapcor delivered their latest profit warnings.

That rule is: Keep an eye on the news flow.

There are times when share prices weaken without negative news or development from the company or the sector.

This does not by definition imply such weakening is out-of-synch with what likely lays ahead, but more often this is due to temporary sentiment or the market getting uppity about a risk that may never eventuate.

This most definitely has not been the case for the companies mentioned. If we move backwards into history, we will find an elongated stream of bad news announcements and developments.

As I have come to discover over time, that’s the red flag we should all pay attention to as investors, in particular when it matters most: when we own shares in these companies.

Having observed this process a number of times now, it’s good to point out the early signs do not start with a big profit warning.

The process is more likely to start with smaller disappointments; the kind we are willing to accept as shareholders, because they do not tend to nullify the investment thesis or the reason why we’re on the register.

Of course, if we were to treat every minor disappointment as a reason to sell, it would be practically impossible to have a longer-term oriented portfolio, but when these disappointments, no matter how small, keep coming, we should pay closer attention.

Just like in Ernest Hemingway’s book, these processes develop slowly, slowly and gradually at first, and then move into the acceleration phase.

That’s usually when Harry Hindsight tells us you should have sold before all this occurred!

As many of you know, my personal investment style is centred around identifying high quality companies on the ASX and owning them for a long time.

That strategy has provided me with lots of joy and rewards most of the time, but I regret not having sold out much earlier when owning shares in CSL and IDP Education was accompanied by such a trend in negative news announcements.

In my defence, as an investor in high quality businesses, I had also learned that those businesses under most circumstances deserve our benefit of the doubt.

Bad things can happen to even the highest of quality businesses, but they tend to bounce back and continue on their path of shareholder value creation, usually not long after.

The All-Weather Model Portfolio owns shares in Goodman Group ((GMG)), Macquarie Group ((MQG)), and TechnologyOne ((TNE)) –all businesses I’d include among the highest quality performers on the ASX—and it’s not like their shares have only moved in a straight line over the years.

As it turned out, giving CSL the benefit of the doubt coincided with a trend in news flow that only kept getting worse.

I’m about to make matters even worse for myself: it can also be argued CSL started tearing down its high-quality image all by itself through, among other things, an over-priced acquisition (Vifor) and a completely ill-timed and misguided attempt to separate its vaccines business.

That plan was not long after withdrawn.

That first announcement was the point when even long-time supporters of the company, myself included, started scratching our heads and raising eyebrows.

Only then discovering there was no appetite for stand-alone vaccines and that separating it from the rest of the business would prove a Gordian challenge pretty much removed the quality label from management.

I think the next profit warning removed it from the business.

I should have acted (sold out) much sooner, there’s no question about it. My CSL experience allows me today to add another example to the red flag rising as negative news starts to accumulate.

It also easily explains why I have no appetite whatsoever to try to bottomfish among the likes of Bapcor, Domino’s Pizza, Healius ((HLS)) or Inghams Group ((ING)).

For starters: I don’t see any quality in either of those companies. More importantly: the bad newsflow is still ongoing.

Bargain seekers beware!

Equally important: it’s never too late to sell.

In times gone by, I have used this maxim through my experience with Slater & Gordon, when I sold for a minor loss and escaped a fall in share price that would not stop until -90%-plus later.

CSL shares are yet a whole lot lower today than earlier in the year, when I finally decided to sell the last remaining shares in the portfolio.

The obvious counter-argument against all of this is that conclusions have been drawn from a limited number of cases and there would be plenty of other examples when the news flow –and the share price—improved just after the decision has been made to sell out.

And that’s probably more than just a fair counter-argument. Strictly taken, we have no way to figure out conclusively that this is how bad things get and the trend will soon turn.

I am sure I can find examples of that if I wanted to, but it’s not that important as I still think selling when negative news turns into a trend is the correct way to respond.

Successful investing is all about managing risk, not about knowing the outcome with hindsight. Sometimes you sell and it will prove the wrong thing to do.

But you have avoided serious damage to the portfolio, and that’s the whole point, regardless of what happens next.

Note also: my decision process pays no attention whatsoever to my entry price. The market does not care what or when I paid to get on board.

The portfolio held those shares in CSL for over a decade, so there was still a “profit” left (if we can call it that) but those shares in Slater & Gordon and in IDP Education were sold at a guaranteed loss.

Praying that things will eventually work out for the best is not a great strategy, even though many an investor has gone down that route.

Then there’s always a worse action to take.

Imagine if I had decided to throw more money at those shares, only to discover the share price would fall even lower, and then persisted in my conviction that all shall come right in the end?

Instead, aware of the risks that remain attached to the falling share price, I actually reduced the portfolio’s exposure during the down-days of owning CSL and IDP Education.

In the end, there was only a small parcel left to sell. That still hurts though, but not nearly as much as had I instead topped up and kept topping up.

I am regularly surprised by how casual advisors and investors alike mention averaging down when a strategy falls flat.

That might work in certain context, but when it backfires, it can do so big time. Which is yet another reason why I never do it.

A failed strategy/purchase doesn’t improve by throwing more money at it.

I only buy more shares at a lower price level when I believe the investment thesis stacks up, not to average down my initial purchase.

No matter how subtle that difference might seem, there is a big gap between the two, and a very big one too.

The conversation touched upon much more, but I leave the rest for another time.

The slides of the presentation will soon be uploaded on the website (see Special Reports, scroll down).

We will also publish a video interview about that presentation (as soon as we can).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)  

P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi’s View stories. Go to My Alerts (top bar of the website) and tick the box in front of ‘Rudi’s View’. You will receive an email alert every time a new Rudi’s View story has been published on the website. 

P.S. II – If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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