Diary of a private investor: a spot of profit warning bother

Given that three of my top-performing stocks were in my largest 10 holdings, I should have had an excellent month, but unfortunately I was hit by two profit warnings on consecutive Mondays. Sprue Aegis (SPRP), the manufacturer and distributor of fire and carbon monoxide alarms, dropped 40 per cent over the month, having at one stage been off 52 per cent, and marketing company St Ives (SIV) saw 50 per cent wiped off its share price. Those two holdings rather took the shine off the performance.

April’s performance demonstrates the importance of a reasonably well-diversified portfolio, with the overall performance of my portfolio just ahead of the FTSE All-Share (Total Return) Index, despite the drag from St Ives and Sprue Aegis.

How to deal with profit warnings

My normal reaction is to cut and move on, as profit warnings are rarely one-off events. Humans are, in general, optimistic beings and management rarely communicates how dire things really are. They may be blind to how bad the situation is or have an innate optimism that things will get better, or even that they can make them better. Trading normally gets worse before improving and, as the old saying goes, “profit warnings are like buses, they come in threes”. Looking at the recent example of Restaurant Group (RTN), the only surprise was how soon the second one came after the first.

With St Ives, I did sell immediately as I was concerned by the wording of the statement, in which it explained that the outlook for its final quarter had deteriorated after a strong performance overall in the year to date. It went on to use those dreaded words “materially below” to describe its expectations for underlying profit for the current financial year. What worried me more was that it also expected these factors to impact on the out-turn for the next financial year starting in August, but did not give any guidance. It seems there is currently little visibility of future trading.

With Sprue Aegis I took a different view. I felt that the problems it had identified with battery failure in some of its 10-year ‘sealed for life’ alarms, for which it had to make a £5.5m provision against potential warranty claims and delay a product launch in Germany, was of a one-off nature from which it could and should recover. I liked the way it clearly quantified the hit to profits and gave clear guidance on 2016 operating profits, split both first and second half (H2). In fact, the H2 forecast of a recovery to £3.8m is ahead of H2 2015 profits of £3.1m. I was comforted by its strong balance sheet (it had £22m net cash at the year-end) and by management having a decent stake in the business. Executive chairman Graham Whitworth owns 7.3 per cent and managing director Nicholas Rutter owns 6.5 per cent.

Sprue Aegis has a leading share in a growing market for domestic smoke and carbon monoxide alarms in the UK and Continental Europe and should recover from this setback. In my opinion, the dramatic fall in the share price left it looking undervalued, so in this instance I added to my position and thus far I have benefited from a 30 per cent recovery in the share price from the bottom. I’m still down 18 per cent on my average purchase price, but am hopeful that it will recover further as confidence returns. It is essential, however, that the company, in Graham Whitworth’s words, “delivers, delivers, delivers”!

Background

Markets made further gains through April with commodities leading the way; Brent crude was up 18.0 per cent to $47.5 (£32.84) per barrel, gold continued its bull run gaining a further 5.0 per cent and even industrial metals such as copper managed a 3.6 per cent gain. Not surprisingly, given the recovery in the oil price (it is up 75 per cent from January’s low), the Russian equity market was one of the best performing, up 8.1 per cent, closely followed by Brazil (+7.7 per cent). Both these markets have gained 21 per cent since the turn of the year. Developed markets in general made further, but rather muted, gains with the FTSE All-Share (Total Return) Index up 1.1 per cent, the S&P 500 +0.3 per cent and the German Dax +0.7 per cent. The Nikkei 225 continued to struggle, down 0.6 per cent on the month and 15.6 per cent since 1 January, although to a sterling-based investor much of this weakness was nullified by the 12.5 per cent gain in the Japanese yen.

Portfolio performance

After lagging the FTSE All-Share for three months on the bounce, it was a relief, thanks to a strong last day, to scrape ahead of the index during April. The gain of 1.3 per cent put it 0.2 per cent ahead in April, but with it down 3.7 per cent since 1 January, I still have a little more to do to catch up with the All-Share’s 0.7 per cent gain. Since inception of the portfolio in January 2012, it is up 113.6 per cent compared with +39.6 per cent for the index, giving a compound annual return of +19.1 per cent, compared with +8.0 per cent.

Five of my holdings gained more than 10.0 per cent on the month: Crawshaw Group (CRAW), the rapidly expanding Northern-based butcher and food-to-go chain, was up 26.8 per cent after posting full-year results; Gem Diamonds (GEMD), +23.2 per cent, continued its recovery on improved sentiment towards the outlook for diamond prices; Vislink (VLK), +19.2 per cent, also continued to bounce back following better-than-expected results in March; BlackRock World Mining Trust (BRWM), +14.6 per cent, benefited from renewed enthusiasm for commodity stocks; and lastly, AdEPT Telecom (ADT) was up 14.3 per cent, helped by its 5 April trading statement, in which it announced a larger-than-expected dividend increase.

Activity

Apart from cutting St Ives and adding to Sprue Aegis, I made a number of other changes. I sold BP (BP.) outright at the start of the month and reluctantly gave up on Next (NXT) towards the end of the month.

I added one new holding, an exchange-traded fund giving me exposure to gold mining companies - the ETFS DAXGlobal Gold Mining Fund (IE00B3CNHG25). I bought a 5 per cent exposure as, in my opinion, having endured a four-year bear market since the price peaked at over $1,900 per oz in September 2011, the gold price looked as though it was back in a bull phase. I am not that big a fan of gold per se, given that it doesn’t generate cash or pay a dividend, but do accept that it provides some insurance during a time of market stress and may come into its own if the current consensus on deflation turns out to be overly pessimistic and inflation rears its ugly head again. By investing in gold mining companies I am hoping for a better return than purely from physical gold. This fund invests in components of the DAXglobal Gold Mining Index which includes the likes of Newmont Mining, Barrick Gold, Goldcorp, Randgold and Newcrest among its largest components.

On 20 April, I sold around 25 per cent of my holding in Baillie Gifford Shin Nippon (BGS) after a strong period of performance; it remains my largest holding at 7.7 per cent of the portfolio. I also added to existing holdings Bioventix (BVXP), Conviviality (CVR), XL Media (XLM) and Fidelity Asian Values Trust (FAS).

Looking forward

This is the most difficult part, and not many of us get it right on a consistent basis; all those forecasts of $10-$15 oil back in February look a little wide of the mark now. Best to focus on the longer-term merits of equity investing and concentrate on picking the right stocks.

This year has been tough going so far and for much of it I have felt as though I have been running up a down escalator. There is still plenty to worry about in the short term; for the UK, the in/out EU referendum in June is the most pressing concern. It looks as though uncertainty is dulling UK economic activity, with decisions being put off until after the result. Consumers seem to be tightening their purse strings when it comes to big-ticket items (as I write I see house prices were down 0.8 per cent in April, according to the Halifax House Price Index) and companies are delaying investment decisions. Whatever the result next month, I think it will help to have the uncertainty removed.

With any luck, the recovery from the January/February lows will continue, helped by accommodative monetary conditions around the world. It would certainly be encouraging if the US S&P 500 could gain another 4 per cent or so and break through last May’s all-time high.