Lessons from a 94.7% profit
Only one winner out of four stocks and that's all it takes to come out ahead in a speculative play
Back in August 2013, gold stocks were deeply out of favour and I asked in this column whether the sector would ever shine again. I put money on the line, backing a handful of junior miners, explaining how in the past I’ve “tried to pick the eyes out of such beaten-down speculative sectors and my conclusion is that it’s better to make a few more individual investments (or speculations, as they might be more properly called) rather than concentrate your firepower”.
It’s now time to revisit the results. But rather than trawl through what has happened at each of the four miners’ operations, more practical investing lessons can be gleaned from a higher-level review. The accompanying share price charts also summarise each stock’s total returns, including dividends, over the past three years.
The first thing that jumps out at me is that three of the four stocks showed negative returns. And two of those were losses of more than 50%. Yet the overall result was a spectacular average positive return of 94.7%.
That’s because Northern Star Resources proved to be an enormous winner, delivering a 522.8% return in just three years. The profits from this one winning stock were more than enough to offset the losses on the three losers and still provide a juicy overall return for the investment in the entire quartet.
This is what the eggheads call “asymmetry of returns”. In the sharemarket, all you can lose is 100% of your investment. But when things go right, you can make a many hundredfold return. It’s a phenomenon that a lot of us struggle with when we first approach the sharemarket. That you could get fewer than 50% of calls “right” yet still produce great returns is counterintuitive. And it’s even more difficult for people in “high stakes” careers to come to grips with – careers where you need to get things right 95% of the time or more.
Consider an anaesthetist. If only one in four patients came out of their anaesthetic as anticipated, the anaesthetist would rightly be considered grossly incompetent. Yet, as we’ve seen with these four gold stocks, the results in the sharemarket from such a low strike rate can still mean a great overall return.
I’ve now sold these four gold stocks for the portfolios I manage, which is something you might consider if you followed suit on
this investment idea. More profits may lay ahead but this result is better than I would have expected three years ago and I’d prefer to have the profits in the bank at this point. For me, junior gold miners were a cyclical play, not a core long-term holding.
Now let’s turn to stocks that are in the doghouse today, ones that might have the potential to produce the kind of gains our group of gold juniors have delivered.
I’ve identified a couple of potential candidates in the online retail game. Both are former darling stocks that have fallen swiftly this year. And the magnitude of the falls has been breathtaking.
Online surfwear retailer SurfStitch (ASX: SRF) is the first. Less than a year ago, investors poured $50 million into SurfStitch. At $2 a share they were valuing the company at more than $500 million, a truly extraordinary number.
The management team of this online retailer of surfwear products was obviously charismatic enough to charm investors into parting with their cash to back them as they expanded well beyond SurfStitch’s successful core business.
Today the shares are changing hands at closer to 20¢ each and the valuation is less than $60 million. That looks attractive to me next to the $61 million worth of cash SurfStitch was sitting on at December 31 (the company has no debt).
Buying companies for their “cash backing” is a time-honoured strategy for value investors, although it doesn’t work every time, of course. The idea is that if you are only paying for the company’s pile of cash, you’re basically getting its business for nothing. If that business is profitable, or has a good chance of becoming so, then the attraction is self-evident.
That said, I’m writing this before SurfStitch has released its full-year profit results. If its cash balance at June 30 is close to that $61 million mark, I’ll be tempted to add to the small position I recently bought. But the company has forecast a loss for the financial year, so it balance may have fallen since December.
The reason it’s cheap is that SurfStitch is a company in turmoil. A co-founder left unexpectedly in March and investors have been surprised by a string of profit downgrades. The most recent one arrived on June 9 and was as severe as it was opaque. It referred to an amendment relating to “the grant of a perpetual licence to a third party”, to use content from a SurfStitch ASX announcement in June.
There was no disclosure of who the third party was and the effect of the “amendment” was negative $20.3 million. But it’s not clear to me whether this is simply an accounting adjustment or an actual cash loss (for instance, if the money had been received by SurfStitch, has it now been repaid?). The full-year accounts should reveal the answer.
All up, it’s a speculative situation in which I won’t be risking too much at this point.
I’ve also been tracking Temple & Webster (TPW), which sells furniture and homewares online through both the templeandwebster. com.au and milandirect.com.au websites.
Its share price has fallen from $1 in December to less than 20¢. That gives the company a valuation of around $20 million compared with its cash pile of $18.4 million as at June 30. Like SurfStitch, Temple & Webster has no debt.
The company expects to lose money again in the 2017 financial year before achieving break even at some point in 2017-18. It hopes to survive using the cash it has on the way to eventual profitability. I’m nervous enough about that prospect to watch from the sidelines for a while yet unless the share price or business prospects change dramatically.
As with the gold miners, I’d prefer to take a portfolio approach with these online retailers. Unfortunately, the markets don’t always deliver what we want and I have only been able to identify these two as potential candidates.
And it’s a shame that I simply can’t get comfortable enough with Temple & Webster to invest at this point. So SurfStitch remains my sole speculation in the sector at the moment.
That you could get fewer than 50% of calls right yet still produce great returns is counterintuitive