Learning from Investment Mistakes: Accrol

Someone wise once advised me that ‘experience is the sternest teacher’.
Few areas of life bear this out more often than the stock market.

Although the loss only amounts to 0.3% of my overall portfolio, my sale this morning of the increasingly distressed tissue paper manufacturer Accrol for about a third of what I paid in 2016 offers an important opportunity to learn from a failed investment.

Despite the unforeseen contingency of a potential health and safety fine being one of the catalysts for the company’s current crisis and share price collapse, as the estimable Paul Scott points out in the Small Cap Value Report , the warnings were there at the time of flotation for those who studied the prospectus with sufficient care.

Concerns about the potential risks of rising raw material prices were also flagged in a company trading statement in September 2017 shortly before the suspension.

Having slept on it overnight on the day after Accrol returned to the stock market I decided to sell first thing at 43p, some 72p below the average price I paid.

So what are the general investment lessons?

1. Investing in initial public offerings is even riskier than general share purchases.

Ask yourself when a company floats on the stock market: why are the owners selling now? What do they know that we don’t?

The flotation documents present the company in the most favourable possible light, but read with sufficient scepticism the potential vulnerabilities can discerned and weighed appropriately. No investment is risk free, but risk awareness must be heightened when a company comes to the stock market.

2. Don’t be swayed by commentators and fund managers.

In summer 2016 I was still too easily influenced by commentators (such as the Investor’s Chronicle which mentioned the shares favourably) and the factsheets of respected fund managers (in this case Gervais Williams who had a position in Accrol in his UK Multicap Income fund).

As I hope to show in a future post, some of my best investments so far have been those I’ve researched independently. There is no substitute for diligent research conducted by oneself – it makes for the right combination of caution and conviction stemming from self-generated and self-owned investment decisions.

3. Debt can be the great destroyer.

Despite raising tens of millions of pounds in the flotation, Accrol still carried nearly £20m of debt. This made it even more vulnerable to the adverse raw material, currency and health and safety costs behind its current difficulties.

So, be ultra-cautious of companies still burdened with debts to repay despite having just raised capital in a flotation or placing.

4. How sustainably profitable is the company’s distinctive offering?

This question should be asked of any investment, but is particularly apt for smaller, newer companies.

Subjecting Accrol to even a rudimentary analysis along the lines of Michael Porter’s famous 'five forces' shaping the destiny of companies, it was easy to see in retrospect how vulnerable Accrol was.

It was a small supplier of an easily substitutable commodity – tissue and toilet paper - to a handful of large, aggressively managed discount supermarkets. Hardly a position of strength from which to dictate terms, not so much a corporate castle behind a deep moat, as a small vessel facing stormy seas.

5. How have I adjusted my approach to investing?

In summer 2017 another flotation, for the kettle component manufacturer Strix promised the same attractive combination of growth and a high yield as Accrol. As with Accrol a number of well-known fund managers opted in at the outset.

However, I looked at the prospectus with a sharper eye this time and noted the ‘risk factors’ laid out in the document (e.g. the largest customer accounted for a fifth of the company’s revenues; it was not clear how much debt the company would be carrying after flotation) and decided not to invest. Time will tell if this was a wide decision.

6. Continue to invest, but with renewed caution

The experience with Accrol has not put me off investing in dividend-paying smaller companies altogether, rather it is a salutary reminder of the risks involved, and the ever-present possibility of loss.

More pleasingly, on the same day as the Accrol sale a couple of smaller company investments in which I have larger percentage stakes - XL Media and Caledonia Mining - have risen by sufficient in today’s trading alone to make up for the Accrol loss. Tellingly, both at the time of purchase and today each of these companies had sizeable cash positions on their balance sheets.

Indeed the whole set of smaller company shares I’ve purchased since late 2015, including Polar Capital, Numis, River and Mercantile, Premier Asset Management, is substantially ahead overall, even with the Accrol loss.

Thus the ‘experiment’ of seeing if individual stock-picking could trump the low interest rate in a Santander 123 account has still been successful overall, so far…

On picking individual stocks

In a previous post from December 2016 I mentioned how a halving of the Santander 123 interest rate to 1.5% prompted me to invest in the shares of Polar Capital, a fund management company.

Although most of my capital has been and is likely to continue be invested in funds and trusts for their diversification benefits, I have invested in a few more individual stocks in recent months primarily in search of yield, but with an eye to future capital growth.

As this has been something of an experiment it’s time for a progress report.

First, the mistakes: in an echo of a previous poor trade in GLI Finance (GLIF) (which I unwound at a 25% loss in early 2016) in 2016 I invested small amounts in KCom (KCOM: the former Kingston Communications with a historic telephone monopoly in Hull) and the packaging supplier Coral Products (CRU). Both had prospective dividend yields in excess of four per cent, both were notable holdings within several successful UK equity income funds.

Yet within six months I’d sold out of both at a loss of 25%.

What what wrong? In a word, results failing to meet expectations. 

In the case of KCom the error stemmed from my failing to pay sufficient heed to the company’s own admission in its 2015/6 Annual Report that near-term revenues might decline as the business restructured.

A sudden share price drop from 120p to 90p last November showed how ongoing growth is essential for sustained share price progress.

In the case of Coral Products a combination of poor execution of expansion plans and excessive debt resulted in a profit warning and a steep share price decline from 23p to below 15p.

With no near-term catalyst for renewal evident in either case I exited both positions.

But – and this is an important lesson – I had a replacement investment in mind. So far it has proved a wise move.

XL Media: Growth without Debt (Part 1)

XLMedia (XLM) makes money from online marketing and publishing. The mechanics of how the company generates profits are explained in its most recent results presentation.

Aside from any ethical qualms about ‘push’ marketing to online gamblers and price-comparison searchers, a major risk here might be regulation. But the company is rapidly diversifying into new revenue sources and thus far has continued to generate impressive growth in cash flow and profits. The recent dividend increase of 5% was a little disappointing but may pave the way for more acquisitions.

The recent post-results rise has given me a paper profit of 30%, almost recouping the loss on KCom and Coral Products within nine months.

The most important factor prompting me to invest was the strong net cash position which stood at $43 million in June 2017. 

Caledonia Mining: Growth Without Debt (Part 2)

A slightly earlier stock pick is also worthy of comment: Caledonia Mining (CMCL). A gold mining company, listed on AIM, based in Zimbabwe…evidence of a foolishly hearty risk appetite on my part? Not entirely.

At the time of my first investment the share price (allowing for a recent share consolidation) was just over £2.00, yet the company had the equivalent of about £1 per share in cash on the balance sheet, was already paying a dividend amounting to 6% and was able to fund a mine investment programme to double production of gold without incurring any debt.

After an astonishing rise to touch £7 at one point, then briefly falling back to £3.50, the shares seem to have settled at just under £5. Meanwhile the gold price has risen to over $1300 an ounce.

The key lesson from Caledonia Mining and XL Media is to look beyond the dividend yield and dig into the balance sheet, the cash resources, and assess the capacity of a company to expand without incurring an onerous debt burden.

K3 Capital Group: Growth Without Debt (Part 3)

My final example dates from just a few days ago: 11^th September to be precise. The Aim-listed broker of small business sales K3 Capital Group (K3C) published strong results five months after its IPO, results strong enough to prompt me to invest.

With a projected dividend yield of around 5%, healthy growth in revenues and profits, and a net cash position, the business has an impetus and momentum lacking in one or two of my investment mistakes: notably the aforementioned KCom and GLI Finance.

Though far too early to judge, the subsequent rise in the K3 share price after the results provides some comfort.

The important lesson from K3Capital is to be alert to a potentially unfolding growth story, whilst ensuring it is based on sound debt-free financial foundations.

What to look for in an individual stock

Individual stock picking, particularly for an income-focused investor like myself, amounts to far more than simply choosing shares with high dividend yields.

Several of the following features should be present:

- a commitment from the management to growing the dividend expressed in annual and interim reports, trading statements, any presentations to investors.

- a capacity from within both cash flows and balance sheet to sustain dividend growth over time.

- growth in revenues, cash flow and profit.

- catalysts for further growth.

- lack of extensive discussion on online forums such as lse.co.uk, stockopedia, advfn

This is perhaps the most important lesson of all: Overlooked companies are more likely to be undervalued.

As ever, the following disclaimer applies: the above is an attempt to explain my investment strategy, not to be taken as financial advice suitable for anyone reading this site.

Time to Panic? Probably not, but...

The last few weeks have demonstrated how apt the title of this blog is.

The indeterminate outcome of the General Election, and the attendant complexities of the UK's exit from the European election, together with the increasing prospect of a Labour government led by politicians philosophically opposed to the profit motive, prompt a rethinking of my investment strategy.

With a significant lump sum to invest over the coming months, both my existing and planned exposures to UK smaller companies merit a closer examination.

That said, the last two years have shown that not only can politics produce unexpected outcomes, the financial markets can respond counter-intuitively.

In June 2016 in the immediate aftermath of the vote to leave the European Union, the domestically focused FTSE 250 index fell sharply, although it had already been in decline since earlier in the month. One of my UK smaller company holdings, the Acorn Income investment trust, fell by 14% in a month. Yet by June 30th 2017 Acorn Income had risen 35% above its July 2016 trough and has increased its dividend from 4p to 4.5p a quarter, yielding about 4% at the time of this post.

Could the expected adverse stock market reaction to a Corbyn-led Labour government, should that come about, prove similarly short-lived? It's hard to tell, but the risks of increased corporation tax, regulation, and a general anti-business tone are likely to be reflected in UK-focused company share prices, at least for a while, were Labour in its current form to return to office.

So, although I'll retain the UK funds I hold as my investment horizon is (hopefully) long enough to ride out political as well as economic storms, at the margin the UK seems a less attractive place to invest for the next few years. Thus, the new funds at my disposal are likely to be deployed primarily overseas, but where?

Income and Growth beyond the UK

I can't predict UK political outcomes and the financial markets' response to them. Nor do I possess advance knowledge of the best-performing overseas investment destinations of the next decade. That said, the fresh capital I'm about to receive offers an opportunity to overcome something of a 'home country bias' in my portfolio.

Here are some of the probable investments I'll be using.

1. JP Morgan Global Growth and Income (JPGI)

I've long been searching for an investment vehicle with a global remit, wholly invested in equities, that yields 4% and does not duplicate the defensive stance of my existing holding in the Fidelity Global Dividend fund.

JP Morgan's Global Growth and Income investment trust (JPGI) meets these requirements. Its excellent recent performance has been in part stimulated by the summer 2016 decision to change the distribution strategy from 2017 to pay a dividend of 4% of the 30th June net asset value in the subsequent twelve months.

The share price growth of nearly 50% from late June 2016 to late June 2017 outstrips the increase in the trust's net asset value, with the discount of over 10% having been all but eliminated.

This performance is unlikely to be repeated, but the trust's certainty of income together with a distinctive portfolio (spanning names not usually found in a global income fund like Google's parent company, Alphabet; the insurer Chubb;  a Finnish steel company called Outokumpu) will add welcome diversification to my UK heavy portfolio.

A recent Edison report on the trust provides some helpful background.

2. Jupiter Emerging and Frontier Income (JEFI)

The JP Morgan trust stretches back to 1887 in its former guise of JP Morgan Overseas. By contrast the Jupiter Emerging and Frontier Income trust was only launched in May 2017. It is far too early to judge performance, but the trust is currently up by 5%, at a premium to its net asset value.

Managed by Ross Teverson, responsible for the open-ended Jupiter Global Emerging Markets fund, the first evidence of the portfolio shows a tilt to East Asia, notably Taiwan, and with the 'frontier' element limited to 25%, the Jupiter trust is less of a pure 'play' on frontier markets than the Blackrock Frontiers trust, which I already hold, and to which I may add alongside the Jupiter trust.

An investor like myself with a time horizon of decades, rather than a handful of years, needs exposure to areas as diverse as Pakistan, Vietnam, Kenya and Morocco.

Blackrock Frontiers has a current yield of 3.5%. The new Jupiter trust aims to pay around 4% dividends.


3. Wisdomtree Emerging Markets ETFs

In a previous post near the end of 2016 I mentioned I was about to experiment in an emerging markets Exchange Traded Fund, specifically from the Wisdomtree stable, the Emerging Markets Small Cap Dividend ETF 

Six months later, and the experience has been mixed. The dividends of $0.42 (approx. 32p; a yield of about 2.7% on my purchase price of £11.80 in December 2016) have been slightly disappointing.

Set against that, the capital performance of DGSE over the longer-term has outpaced most near equivalent income-seeking emerging market investment trusts and open-ended funds. So I may consider adding to this fund, and others from this company, e.g. the Wisdomtree Emerging Markets Equity Income ETF.

4. Other possibilities 

In search of growth and income around the world, a variety of potential investments are catching my attention:

Blue Planet Investment Trust

A tiny trust, gross assets of £40m, that has announced a dividend of 4.7p (yield of nearly 9% on the current buy price of 52p) payable in August. Ex-dividend date this coming Wednesday 5th July. Perhaps its recent big bets on emerging market debt (12% of the trust is invested in a Brazilian government bond) have had the best of their run; and a dividend paid once a year and subject to such vagaries as this year's over 50% increase may not be the most reliable.

Centamin (CEY)

I already have some funds invested in miners: Caledonia Mining (CMCL), main asset a Zimbabwean gold mine, and Central Asia Metals (CAML), main asset a Kazakhstan copper mine. So why is Centamin - primary asset the Sukari gold mine in Egypt - piquing my interest?

The share price has slipped from 190p to 155p since April, but the company has nearly $300m in cash and last year paid a dividend of $15.5 per share.

Dividend-paying gold miners might be a useful hedge against political and stock market instability in the months and years ahead.

Disclaimer

As ever the above are notes about my own investment thinking. You should not take them as advice for your own, potentially very different, personal financial situation.

My last salary-funded ISA?

In a previous post I reflected on the likelihood of future tax increases and the probable removal or reduction of various investor-friendly tax concessions.

Whatever the result of the June 2017 election, the rhetoric during the campaign makes such measures more likely in the coming months and years.

In view of this, and my impending retirement from full-time paid employment, the wise allocation of capital to the 2017/8 ISA takes on even greater significance.

I've allocated all the but the last £4000 (leaving that until after the result on June 8th) and reached my decisions on the first £16,000 in the light of these thoughts:

1. Don't isolate a single year's ISA from the rest of your investments.

In my case with part of the proceeds of a property sale to come later this year, the ISA funds have been deployed to high yielding investments with an overall income target of 5% (i.e. £1000 of tax free income).

2. Embed your ISA objectives within your overall investment objectives.

My first priority is to maximise tax-free investment income, hence the tilt to higher yields within the tax-free shelter.

3. Don't ignore investments you already have and that have proven their worth.

I've tried to resist adding several new holdings, instead deepening rather than widening my investment selections where possible.

4. Don't chase the very highest yielding investments without regard for capital growth.

My initial early retirement plans a few years ago envisaged a high allocation to 'enhanced income' funds such as the Schroder Income Maximiser family. Closer analysis, and the experience of a near relative whose immediate income needs override all other investment goals, have made me realise that high current yield can come at the expense of capital growth, so I have tempered my projected allocation to these funds.

5. Remember that it's possible to transfer funds within a Stocks and Shares ISA.

Although I don't invest in ISAs with a view to actively trading them, like all parts of a portfolio they can be amended if investments fail to meet their objectives. I have switched some positions to good effect in past ISA years, so although this year's investments are meant for the long term, they will not escape scrutiny.

So what have I invested in?

My 2017/8 ISA selection

1. European Assets Trust (EAT)

I've added another £4000 to last year's investment in this European small and mid-cap investment trust. Having struggled for much of 2016, this year has seen an uptick in performance as the European recovery starts to gain traction. The yield of 6% of each year's starting net asset value paid out over the following year means that the dividends can fluctuate: 2017 looks like being 67p for the full year against 73p in 2016, 55p in 2015.

2. Central Asia Metals (CAML)

An AIM-registered copper mine in Kazakhstan...hmm...
In fact CAML was one of my switched ISA holdings that worked in 2016, and wanting to raise my allocation to the mining and commodity area as the portfolio grows, I decided to add to my holding. This year's investment is down a few per cent thus far (partly as a result of the 10p dividend recently declared) but with a healthy balance sheet and generous dividend yield, this is one for the long-term.

3. XL Media (XLM)

I like to have one somewhat speculative 'play' in each year's ISA. Last year was Caledonia Mining (CMCL), this year in a desire to gain some exposure to the world of online publishing and media marketing, I invested in another cash-rich AIM stock, this Israeli media marketing firm. Already a few per cent to the good...

4. Premier Optimum Income (C Income)

To attain my 5% yield target at least one of the components had to have a yield in excess of 6%. Less well known than some of its fellow enhanced income funds that employ call options to boost their dividend payments, Premier's fund has the best capital growth performance of the set (over 5 years to 2nd June 2017 the capital value of the Income units has grown by 44%, compared to 32% for Schroder Income Maximiser) and a similar yield of about 7%. The Premier fund does not have some of the usual dividend suspects in its Top 10 holdings (e.g. B.P. and Shell).

5. Chelverton Small Companies Dividend Trust (SDV)

This is where the £4,000 I have yet to invest this year will be directed.
I am holding back for the moment, partly because of the narrowing of this trust's discount in recent weeks, partly in case we see a surprise UK election result denting the rise in UK small cap valuation which has been such a feature of the first half of 2017.

The strong performance of this trust over the last five years (net asset value up 221% in the 5 years to June 2nd 2017) - some of which I've enjoyed in previous years' ISAs - merits a further investment.

Near misses and candidates for my non-ISA investments

Had it been launched a few weeks earlier, I might have included the newly established Jupiter Emerging and Frontier Income trust (JEFI).

My long search for a global income trust yielding 4% and not at a high premium (perhaps ruling out Murray International) has led me to JP Morgan Global Growth and Income (JPGI) which in 2016 changed its investment policy to pay 4% of each year's 30th June net asset value in the following twelve months. I will explore this trust in a future post as it may provide a home for some of my property sale proceeds.

In Appreciation of Share Radio

Amidst today’s discussion of local and mayoral election results one sad loss from the British media landscape should be marked. After only a short time on national DAB radio Friday 5th May 2017 is the last day of broadcasting on that medium for Share Radio.

Although my financial self-education was already well advanced, my listening to the station since it went UK-wide in 2016 has considerably deepened my knowledge of investing and the political context shaping personal finance.

The station introduced me to a range of voices I wouldn’t otherwise have heard (e.g. Russ Mould, Chris Bailey, Rodney Hobson) and provided specialist shows on investment trusts, crowdfunding, emerging and frontier markets whose breadth and depth of content put the BBC’s scant coverage of business and finance – especially on national radio - to shame.

Indeed from Monday 8^th May 2017 unless Share Radio’s estimable Market Wrap feature survives in the station’s reduced online form there will be no comprehensive evening analysis of the day’s business and finance news on UK national voice-based media.

If Share Radio no longer has the capacity, surely someone else should step up to provide a much-needed conversational distillation of the day’s company announcements and market movements for the ever-growing private investor community? 

A Stockopedia daily podcast perhaps?

Or maybe like more and more aspects of investing itself, this is something I/we may have to do for ourselves?

The Uncertain Certainty of Taxation

Benjamin Franklin’s oft-quoted statement, “In this world nothing can be said to be certain except death and taxes”, will take on a renewed truth whatever the result of the imminent UK General Election of June 8^th 2017.

The now aborted (but only temporarily) Budget measures reducing the dividend allowance to £2000 per year from April 2018 and attempting to raise probate fees from a flat rate of £215 to a sliding scale of up to £20,000 shows the direction of travel in government policy.

As a soon to be non-working, single, childless person I’m the exact opposite of the ‘hard-working family’ at the forefront of the carefully/carelessly crafted soundbites and subsequent often ill-thought policies masquerading as pledges that pass for contemporary politics. As such my already taxed income and savings will be the target of whoever is the next Chancellor.

It’s worth noting how adverse the tax position of those seeking Financial Independence and Early Retirement has become. Prior to George Osborne’s wheeze of abolishing the dividend tax credit system and introducing the current £5000 per annum dividend allowance it would have been possible for me to earn over £40,000 per annum from my investment portfolio and not worry about income tax.

You may well ask, why should portfolios of over (say) £250,000 be free of tax? To which my retort is simple: why should income I (and my ancestors) have already paid tax on before investing in the assets generating those dividends be taxed again? Why should our prudence be punished? Those are rhetorical questions of course, as the size of the current government deficit and debt provide some of the answer.

Rather than bemoaning this, just as my financial planning has assumed little or no state pension and little or no occupational pension, the recent Budgets and those likely to follow require anyone seeking or already in the state of financial independence to assume that many if not all of the following will come to pass:

1. The Dividend Allowance will be abolished altogether and/or the accompanying dividend income tax rates of 7.5%, 32.5% and 38.1% will be increased [perhaps in stages like the Insurance Tax] to match the prevailing rates of income tax (20%; 40%; 45%).

2. Schemes providing tax relief: notably pension contributions, Venture Capital Trusts, Enterprise Investment Schemes, will, if they survive at all, at best have relief restricted to the basic rate of income tax of 20%.

3. The Capital Gains Tax net will be cast more widely. The rates are unlikely to stay at 10% and 20%. The annual allowance (currently £11,300) may not survive at all, or at best be drastically reduced, severely constraining the ability to swap income generating assets for ‘growth’ investments partially sold down each year to create ‘home-made’ dividends.

In short we can be certain that those of relatively moderate means seeking to live off income from investments rather than employment will pay more tax in the future. The only uncertainties are details and timing.

What if 'Value' is already too expensive?

One of the major themes in recent investment commentary is the return of ‘value’. After several years when both ‘growth’ stories and the quest for yield outperformed value-based strategies, the last 12 months has seen a dramatic rotation of capital to value shares and strategies.

In 2016 the MSCI Growth Index grew by only 3.21% against 8.15% for the MSCI World Index, this being the first significant calendar year under-performance for Growth since 2004.

Conversely, in 2016 the MSCI Value Index grew by 13.23%, the first significant out-performance of Value since 2006.

What has driven this performance and could it last?

An interesting way of tracing the sources of value’s apparent renaissance is to explore the recovery of recovery funds.

In the year to 17^th February 2017 the highest performing funds in the UK All Companies Sector over a 12 month period had a ‘recovery’ stance:

Standard Life UK Equity Recovery up 77%

River and Mercantile UK long Term Recovery up 44.9%

M&G Recovery up 39.6%

Schroder Recovery up 36.8%

Scanning their top 10 holdings the obvious catalysts include overweights to the mining sector (Standard Life: Anglo American and Glencore); banking (River and Mercantile: HSBC, Lloyds); and energy (M&G: BP); and a broader positioning of the portfolios away from winners of the last few years such as consumer staples.

Some of the fund managers concerned such as River and Mercantile’s Hugh Sergeant in his ever readable Quarterly Report argue that value’s resurgence has only just begun: “This is a profound shift and my key message is that we are only at the beginning of it. Like all trends it will not be a straight line, but the change of direction is clear.”

Schroder’s value team state:

"Where we do feel confident, however, is that, over the longer term and after what represents only a small-tick-up in a very long period of underperformance, value looks well set."

I hope they're right, but I doubt that value's high returns of the last 12 months will easily be repeated. Will HSBC or the mining companies such as Glencore nearly double or more again in the next 12 months? It's difficult to discern an obviously cheap but still investable sector in the UK stock market.  Perhaps global diversification with a value bias is the answer?

Go Global; Go Passive?

There is no shortage of passive value options: the Vanguard Global Value Factor ETF (VVAL) was up 54.9% in the year to 17/02/2017, although interestingly River and Mercantile World Recovery B Inc was up slightly more at 58.5%, and Standard Life UK Equity Recovery rose by 77%.

Yet one does not have to go back far to be reminded that value investing's long-term gain can involve severe short-term pain:

From Feb 2015 – Feb 2016 the World Recovery fund fell by over 13%; Standard Life Recovery fell by 17.9%, even Vanguard's Value Factor fell by over 10% in the first few weeks after its late 2015 launch.

When it works, value investing really works, but with sustained periods of underperformance a given, it is is not for the faint-hearted.