Six portfolio failures and four lessons for long-term investors

Our shares analyst Richard Beddard explains his portfolio making tool and considers individual decisions made in 2019.

Last week, I reflected on the impact of the decisions other investors have made on the shares in the Share Sleuth portfolio, the model portfolio I run for Money Observer magazine using the Decision Engine as my guide. Generally speaking they bought the shares I had already added to the portfolio, which has, temporarily at least, resulted in a strong performance (yay! Happy Christmas) but also in higher valuations (boo! I’m going to have to work hard next year to dig up some bargains).

This week I am continuing in a reflective vein, to consider the individual decisions I made in 2019. For the first time, I added shares in Avon Rubber (LSE:AVON) in January, RM (LSE:RM.)in May, Anpario (LSE:ANP) in June, and Bloomsbury Publishing (LSE:BMY) in November. I topped up the portfolio’s holdings in Goodwin (LSE:GDWN) and XP Power (LSE:XPP) in January and Quartix (LSE:QTX) in February. And I trimmed the portfolio’s holdings in Tristel (LSE:TSTL) in January and Judges Scientific (LSE:JDG) in November. 

I won’t be examining these trades. The four new additions were all acquired after I profiled the companies here on interactive investor. The top ups and trimmings were no-brainers, decisions driven by each share’s weight in the portfolio. I remain committed to all these shares, but the Decision Engine, my portfolio making tool, calculates the ideal size of each holding based on its score, the higher the score the greater the weighting. The Share Sleuth portfolio had too few shares in the companies I topped up and too many in the holdings I trimmed.

Six portfolio failures

Lessons can be learned from the shares that exited the portfolio because they are failures, although not necessarily in the conventional sense. Some of them, Vp (LSE:VP.). for example, made a strong contribution to the portfolio’s performance. Science (LSE:SAG) earned the portfolio decent returns too. Only System1 (LSE:SYS1) lost the portfolio money. They’re all failures, though, because I no longer felt I could hold them indefinitely. I lost confidence in their long-term investment potential. Something about them had changed, or something about me, which reduced their Decision Engine scores.

The first two shares to go exited the portfolio in January. Finsbury Food (LSE:FIF) is a baker supplying cakes to supermarkets and the hospitality industry. When I added the shares it had not made an acquisition since the financial crisis when it was brought to its knees by a combination of weaker trading and debt from an earlier acquisition fueled expansion. I had hoped it might find a way of growing organically, but now it has embraced acquisitions again I fear history might repeat itself. It needs scale to drive efficiencies and profitability as its powerful customers bear down on prices. 

I had always felt MS International (LSE:MSI) did a poor job explaining its business, and it was becoming an increasingly complicated one as it added petrol station signage to fork lift blades, petrol station forecourt structures, and naval cannon to the roster of products its subsidiaries manufacture.

Vp, which left the portfolio in February, was a specialist hire firm with less debt than most hire firms, but it seems to be getting less specialised and more indebted as it grows. Though I had some theories, I no longer felt I understood what made it special and the company’s annual reports and websites did not help much.

Science, which left the portfolio in May, did scientific research connected with new product development for non-military customers and also advised them on issues like regulation and intellectual property. It still does, but the company’s executive chairman, who has a controlling interest, is, through acquisition, ploughing the consultancy’s cash flows into unrelated businesses, turning Science into an investment vehicle. I have no idea what it might invest in, so I am simply unable to assess the risks or the strategy, which is why I said goodbye to the shares. 

It was lack of ambition that did it for Colefax (LSE:CFX), which departed in September. Colefax supplies luxury fabric and wallpaper decorated with classic and contemporary designs. The company refreshes its collections every year, which keeps the profits rolling in, but it hasn’t launched a new collection, or acquired one for decades, preferring instead to buy back its own shares with surplus profit. If the company lacks investment opportunities, buying back shares may be the best option but I would prefer to focus on businesses that can grow themselves.

In July, System1 left the portfolio. It was perhaps the toughest decision. System1 shows TV advertisements to people and asks them how they feel about them. This, the company claims is vastly more predictive than traditional market research.

Unlike some of my other failures, management couldn’t have been more accommodating, answering my questions about what makes the company special and the challenges that have stopped growth in its tracks, principally getting regular work from the major fast moving consumer goods companies that use it on an ad-hoc basis.

Much bigger, but less predictive, rivals have automated software platforms that plug into their customers’ systems, which System1 is seeking to replicate. But that requires System1 to develop new technological capabilities and market them. My heart told me stick, because I admire the managers and tend to root for David against Goliath, but me head told me to twist because I couldn’t assess the risks.

Four lessons for long-term investors

Six exits out of a portfolio of 25 or so is too many for a buy and hold investor. Sustained, it equates to a holding period of about four years.  I am not going to beat myself up though. The intention is to buy and hold indefinitely, but that won’t always be the reality. Hopefully as the quality of the businesses improves, there will be fewer casualties.

The old adage “buy what you know” is true, otherwise as we get to know our shares better, we will find things that make us doubt them. Many of these companies were not telling me what I felt I needed to know, but I did not recognise that at the outset. While we can never know everything, I did not know them well enough. 

Gains from share buy-backs are limited because ultimately there will be nobody left with shares to sell. If a company’s investing in developing new products or services the gains can be much greater. I would rather invest in companies that have the confidence to invest and grow their businesses, rather than shrink their share counts.

My final lesson is a contradiction of another old adage, never to fall in love with a stock. Blind love is dangerous, but when doubts about Finsbury Food and System1 began to nag at me, I didn’t think more cake and more feel-good advertisements were causes I was willing to go to battle over, which also encouraged me to look elsewhere for my investment returns.

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard.