Being a contrarian can be a lonely existence. It involves doing nothing for long periods of time. And then when you do something, you are usually going against conventional wisdom at the time. But loneliness is not the hardest part of the job. The hardest part is being an obvious idiot when you get things wrong.
All investors make mistakes. Most successful investors say the best you can expect is to get six or seven out of 10 right. That’s been consistent with our experience over the past decade. The difference as a value investor is that you get things wrong in ways that are obvious, seemingly stupid and embarrassing.
Into the face of Jumbo concerns
Online lottery ticket reseller Jumbo Interactive (JIN) is a darling growth stock these days. But it wasn’t always that way.
We first bought into the stock at around $2.50 a share. From there it fell more than 60% and we added significantly to the holding at less than $0.90 per share. As a value investing opportunity it was simple. Its market valuation was just $39m. It had $17m in cash, a pile of franking credits and an Australian business making $8m of pre-tax profit a year.
But the issues with the business were well known in 2015. Jumbo was wasting money on international expansion gambles in Germany, the US and Mexico. It had one critical supplier, Tatts Group, that could terminate its distribution agreements and kill the business overnight. And, perhaps most worrying long-term, Jumbo sells exactly the same product as Tatts for a 10% premium. Why does anyone even use it?
When the share price was getting hammered, everyone was focussed on these flaws in the business model. Blind Freddy could see that this business didn’t have a future.
Taking a contrarian view involved coming to terms with just how much money would be wasted, how profitable the Australian business could be and what the chances were of losing that big supplier.
Jumbo turned out well — the stock is up from $1 to $6.50. But imagine if Tatts had pulled the pin soon after we bought it. It would have been easy for our investors to turn around and say: “you guys should have seen that coming — everybody else did”. Which, of course, is why the opportunity was there in the first place.
Wrong on Freedom and looking stupid
The Forager Australian Shares Fund owns funeral insurance company Freedom Insurance (FIG) in its current portfolio. Freedom’s share price is down more than 60% over the past two weeks after being called before the Royal Commission into Financial Services and the release of an ASIC paper condemning its business model.
Forager made the investment knowing that Freedom’s sales model was potentially flawed. Here’s what I wrote in our research document in November last year:
“The direct sales business model could come under threat. Regulators could require personal advice to sell life insurance products, for example. There’s something ugly about phone sales of insurance product and I can imagine it getting a lot more scrutiny if it continues to grow. I would put the probability at low but meaningful and the impact very high.”
A probability assessment of “low” can be debated. The point is that we made the investment knowing full well that there was a chance of something very bad happening. We thought there was enough potential upside to compensate for that risk and that there was some downside protection in the company’s existing customer base (the latter part of that thesis is about to be put to the test).
In Freedom’s case, unlike Jumbo, that risk has become a reality. And when a risk that everyone was worried about comes to the fore, the nuance of chance and probability gets lost. It simply looks like we failed to understand something that was blatantly obvious to everyone else.
Making mistakes is something you get used to quickly in this business. Regularly looking like an idiot, though, is something I find much tougher. For me, that’s the hardest part of being a value investor.
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I don't think it looks stupid. It only looks stupid for people who are wrong.
Does that mean you’re selling out?