From dreadful mistake to 12-bagger – why it (sometimes) pays to hang in there

David Guy

Leithner & Company Ltd

“Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
- Warren Buffett

Investing is full of aphorism’s similar to Buffett’s above; basically, that the most important part of investing is controlling your emotions. Hopefully this article gives you some idea of both how hard that can be and also the rewards that can come from it.

Picture what you were doing in 2002. Ah, they were simpler times. What I was doing in addition to working my butt off was helping my mother manage her SMSF. She lived solely on the capital and income from this SMSF so it was a pretty big deal that I got things more right than wrong. Below are the purchases that her SMSF made in one particular ASX listed stock:

Date

Cost/Share

5 March 2002

$0.336

28 May 2002

$0.301

29 May 2002

$0.300

3 June 2002

$0.300

5 June 2002

$0.300

6 June 2002

$0.300

17 February 2003

$0.200

3 July 2003

$0.066

8 October 2003

$0.065

5 August 2005

$0.085

Average Purchase Price

$0.148

Having done extensive research on this company and its industry as you can see I had a little nibble to start with and then I bought some more, and some more, and some more … you get the idea.

This is called “catching a falling knife” (which I always sing to the tune of “Catch a Falling Star”, “Catch a falling knife, don’t let it rip your hands off, don’t be too greedy today”) and it seems to be looked down upon by most professional investors. Why? Well, primarily because you can look awfully stupid doing it. Most professionals are judged on their short term track records just as much as their long term track records. Accordingly, they have become much more short term focussed and anything that detracts from short term performance is quickly ejected from their portfolio (you have heard the platitudes: “Cut the losers and let the winners run”, “We like this name a lot, but set a stop loss just in case”). But it is my belief that this sort of action can both hurt long term returns and (or maybe because) it introduces excessive trading.

But what about Mum’s SMSF ? Unfortunately, after the last purchase things got worse … much, much worse.

By January 2007, the shares that I had bought at an average price of 14.8 cents were selling for 5 cents, were not paying a dividend and despite the company being conservatively financed and managed it was, to be honest, not doing too much. And then came the GFC …..

By June 2009 the share price was at 2 cents per share which for those counting represents an 86.5% fall. Ouch. It’s fair to say that Mum was only talking to me by this stage because I am her only child (though I should also point out that this investment was only one of several in her SMSF – appropriate diversification is important). And it was embarrassing. I still didn’t think the company was too bad, the pricing remained attractive and it was producing modest earnings but it was going nowhere. What to do ? Accepted wisdom would probably be to move on. Fortunately though, I am stubborn, I was only answering to my Mum (rather than asset consultants, shareholders, clients etc) and honestly the $74,181.55 investment had fallen to $10,000 (less brokerage) – what was the point in selling?

By October 2013 things had improved – we had made it all the way back to 9 cents per share. And we had even received a 0.5 cent per share dividend the month before to make 9.5 cents per share in total. Now I know that an awful lot of people, professional and amateur alike, would have cut their losses at that point – we were only down $26,681 … move on David, you can’t win them all, you don’t need to make it back the same way you lost it.

Maybe I should have ….. by December 2014 we were back down at 4 cents per share. But at this point I probably committed my biggest error. Having ridden this thing for 12 years, understanding the company and the industry well and seeing the company focus solely on operations (they had only very mildly diversified – from memory, at one point they decided to hold an ASX listed portfolio on balance sheet, which was decidedly non core. I mean it’s not the same as a listed fund manager diversifying into a Mexican fast food chain or a global tech CEO deciding he can also operate coal fired power stations, but it was still a distraction) did I do the obvious thing and double down, triple down? Swing for the fences? Nope, I did nothing but twiddle my thumbs. A massive opportunity cost, but at least I didn’t sell.

For, as often happens at some point if a company represents good value, all of the things that the market previously discounted got turned on their head (“it’s too small, it’s only growing slowly” becomes “it has lots of upside and is growing consistently”) and things started improving. Slowly they moved up to 11 cents per share by August 2015 and then they popped – up to 34 cents by September 2015. Woohoo – Christmas was going to be much more comfortable this year!

They commenced consistently paying dividends in September 2016 (and haven’t missed a half yearly dividend since) and their share price marched pretty consistently in line with their improving operational performance so that by early March 2022, after twenty long years the share price had reached $2.05 per share.

Mum’s SMSF has received $0.448 (or $0.64 grossed up) per share in fully franked dividends and has shares worth $2.05/share from its initial investment of $0.148/share for an average annual compound return of well over 15%. The dividend for the last 12 months alone was $0.10 per share ($0.1428 grossed up or 96% of the initial investment amount.)

Lessons?

  1. You are not necessarily wrong just because “the market” doesn’t agree with you in the short, medium and sometimes even the long term;
  2. If a business remains attractive and the market pricing of that business remains attractive then you need to objectively review where you are at – would I buy this share at 4 cents, knowing what I know? If so, and provided that you would remain appropriately diversified then the fact you initially paid 33.6 cents for the same share should not preclude you from buying more;
  3. Would I have been able to hold on through such a rollercoaster ride if it wasn’t my own Mum’s SMSF? I don’t know, I honestly don’t know. But I will say that it would be much harder for an investor in a professional capacity to continue to hold;
  4. Investors may do better in the long run if they are not forced to make investment decisions based on non-financial factors (embarrassment, sick of explaining negative results to clients etc). In that regard, individual investors who have the right skills and temperament (or professionals who are unconstrained by popularity) may have an advantage over “the market” as they are answerable only to themselves (and perhaps their Mum!)

“Your investor's edge is not something you get from Wall Street experts. It's something you already have. You can outperform the experts if you use your edge by investing in companies or industries you already understand.”

Over the past three decades, the stock market has come to be dominated by a herd of professional investors. Contrary to popular belief, this makes it easier for the amateur investor. You can beat the market by ignoring the herd.”

“Often, there is no correlation between the success of a company's operations and the success of its stock over a few months or even a few years. In the long term, there is a 100 percent correlation between the success of the company and the success of its stock. This disparity is the key to making money; it pays to be patient, and to own successful companies.”
- Peter Lynch

P.S. I have ummed and ahhed about disclosing the share in question. I have decided to disclose as it is easy enough to find with a bit of digging and someone might gain some benefit by checking out the history of the company etc. HOWEVER all readers should be aware that the fact that the SMSF continues to hold the share is not in any way a recommendation in relation to that share and indeed the SMSF may sell at any time – it is certainly the case that most shares are, at a minimum, fully valued at present and this is likely no exception. The company is HiTech Group Ltd (ASX: HIT).

P.P.S. How big was the twiddling the thumbs error ? Massive. Buying more shares at 4 cents in December 2014 and holding them until now would have resulted in over 60% per annum compound returns. I can console myself only with the fact that I would not have been able to allocate much capital to the investment as the market capitalisation, trading volumes and free float were so small. But still ….

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This article contains general information and does not take into account your personal objectives, financial situation, needs, etc. In other words, we (David Guy and Leithner & Company Ltd AFSL 259 094) are expressly not providing any advice to anybody in this article and intend only to discuss topical investment subjects in a light hearted manner.

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David Guy
Joint Managing Director
Leithner & Company Ltd

David has both a Bachelor of Laws and a Masters of Applied Finance. He is also a Solicitor of the Supreme Court of Queensland. David’s career started in law in 1994 before devoting his focus to financial services from 1996. Since then, his career...

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