This year is a case in point as following a haul of winning buy recommendations over 2012 and 2013, and holdings almost entirely focused on the small cap segment of the market, the increase in risk aversion over the past seven months has dealt a hammer blow to the minnows of the stock market. In this period the FTSE Aim index has officially entered a bear market, falling 25 per cent since March. In the circumstances investors have been far more inclined to trade and bank short-term profits. My preferred buy to hold strategy has not worked for the most part. I have to accept that fact and had I anticipated a 25 per cent sell off in Aim shares at the start of the year then I would have adjusted my investment strategy accordingly. In the same way if the world’s greatest investor Warren Buffett had anticipated the problems at two of his investee companies, IBM and Tesco, I am sure he would never have invested in the first place.
That said, and as I have always done so in my writings for Investors Chronicle, I have given my view on what I perceived at the time to be the correct advice and one that I had anticipated would reward readers. I can only analyse the investment case on a company as it is presented at any point in time and then reach a rational conclusion as to what I feel a sensible valuation should be. The fact that an above average number of my share recommendations have fallen this year highlights a number of things.
10 Lessons to learn
Firstly, and is the most obvious point, shares only go up if the operational performance justifies a higher rating and one that is not in the price when they are purchased. Some of the companies I have been following have warned on profits which create an almighty headwind for them to enjoy share price outperformance.
Secondly, it is clearly more difficult stock picking in a market heading southwards than one heading north. The margin for error is far less when investors have much higher risk aversion. Equally, good news is less well rewarded too.
Thirdly, and a fact that became apparent in the frothy market environment in the first quarter this year, some investors have been taking a very speculative approach with my recommendations and have been buying blind. That is the polar opposite of what I would recommend to anyone. I always believe that my analysis should be the starting point and the spark to ignite interest in a company. It is down to readers to do their own research too and then decide whether the investment case is strong enough to warrant having a financial interest.
Moreover, it is down to each individual reader to decide at what price point the risk:reward ratio is favourable to them. I express my view, and sometimes strongly, as to what I feel. However, that is all it is: a view. It has never been a cast iron guarantee that share prices will rise and in no way is it a signal to bet the bank on any one recommendation I make. That is clearly a risky strategy to adopt. I am also convinced that this has accentuated price falls as the speculative money leaves the table.
Fourthly, if some investors are paying too a high a price in the first place because they have been chasing the price, then this leads to greater volatility in the shares I recommend. As a consequence this volatility increases if one of my investment calls goes wrong.
Market makers are not stupid and will have a list of the companies I recommend. So just as they mark prices up to take advantage of a spike on initial buying interest, they can also aggressively drop prices to shake out weak holders on any adverse newsflow. To compound matters, if the majority of the buying has been from Investors Chronicle readers who are following my articles, then if the newsflow becomes negative then this segment of investors will constitute the majority of the selling too. In small cap shares with their reduced liquidity this can accentuate price moves, both to the upside as well as the downside.
Fifthly, when share prices hit my target prices – recent examples include marine operator Sutton Harbour (SUH: 35.5p), support services group Renew Holdings (RNWH: 317p) and aircraft broker Hangar 8 (HGR8: 311p) – then more investors are now inclined to bank profits than was the case six months ago. Again this creates more volatility in my share recommendations and leads to sharper than normal price falls on the winning holdings once they have hit my targets. I have seen this on medical equipment firm Tristel (TSTL: 78p), a company whose share price had risen 50 per cent on my buy recommendation this year.
Sixthly, when shares in companies I have successfully recommended hit my initial target prices I have sometimes raised those targets. Both online gaming company Netplay TV (NPT: 8p) and marine services company Thalassa (THAL) are very good examples as both had doubled in value by January this year. However, in both cases my original targets in hindsight represented full value and the subsequent derating, in part down to lower than expected growth expectations, led to a significant sell-off.
The fact that I failed to see the signs that the shares had peaked and the operational performance was about to deteriorate in both companies should not detract from the important point that the original buy advice, and the rationale supporting it, was correct in both companies. However, with so many readers sitting on paper gains, then this created greater selling as many tried to get out and crystallise some of those gains when the shares went into retreat.
My seventh point is that I underestimated the investor scepticism towards Chinese Aim-traded shares and included three companies in my 2013 Bargain share portfolio: clothing companies Camkids (CAMK: 50p) and Naibu (NBU: 22p) and energy services group Fortune Oil (FTO: 7.9p). However, I still believe the rationale for making the recommendations in the first place were fully justified by the fundamental case to invest at the time. In the case of Camkids and Fortune Oil that is still the case.
My eighth lesson this year concerns small cap resource stocks. It is fiendishly difficult to make a positive turn on a company in a sector that is in a bear market as is the case with this particular segment of the market. This partly explains why both SouthAmerican oil producer and explorer Global Energy Development (GED: 52p) and Aim-traded investment company Polo Resources (POL: 8.5p) have underperformed badly this year, although clearly as I have discussed in my articles on both there are also company specific reasons too.
Lesson nine is perhaps the hardest one of all for any investor to adhere to: if a trade is under water, then be ruthless when timing your exit. The mental energy expended on a losing position is far greater than the euphoria generated on a winning one. Clearly, I should have been more ruthless this year.
The final lesson I have learned is the greatest one of all. It’s fine focusing on one segment of the market, but it also pays to keep a closer eye on the bigger picture. In the case of equity markets, there were some warning signs that a correction was coming but I underestimated them and could easily have taken out some protection to hedge off the risk. A valuable lesson learned for the future.
Please note that I have written two other columns today, both of which are available on my IC homepage...
I have also written three articles in the past week on financial markets:
Equities: Eurozone growth scare spooks investors (13 October 2014)
Monetary policy: Normalisation is coming so plan ahead (17 October 2014)
Bond markets: Lessons to learn from bond market flash crash (17 October 2014)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
