Ennstone – post trade analysis

I’m going to record an analysis of each of the trades that I make so that I can learn from each trade.  I’m sure that sometimes there may be nothing to learn, but that’s not always going to be the case and it certainly wasn’t with my first value stock back in 2008.

I had come to value investing from a more typical mindset where I was trying to predict the future in order to see where it was going to be most profitable to invest.  I had been heavily invested in energy stocks through unit trusts back in 2005-2008 and they’d done incredibly well, almost doubling my money.  But I had no idea how to value these unit trusts nor the stocks within them.  When oil went to $146 I thought I was pretty smart.  But we all know what happened next.  I lost about 50% and that’s a really big drawdown, one that made me almost physicall sick.

I’d become aware of Warren Buffett and Ben Graham and had read some research on low price to earnings and low price to book stocks (some of which I’ll link to soon).  So as reality taught me that I was, much like almost everyone else, really bad at seeing the future, I started reading more and more about these unusual characters.  The basic idea struck a chord with me and just made sense.  Buy things when they are cheap and everything else is immaterial.  At least, that was my original interpretation.  I preferred (and still prefer) the Graham approach of thinking that beyond a certain degree, analysis is futile.  The future is unknown, it always was and always will be.  The only thing that changes is how much you think you know about the future.

So there I was, a follower of Graham, armed with stock screeners and an investing framework (low PB, lots of diversification and patience) and into my view fell Ennstone.  But Ennstone was cheap for a very good reason.  It had a lot of debt that was due to be repaid soon and it had no way to repay it.  New covenants could not be agreed and sadly Ennstone went into bankruptcy.  I hadn’t even had time to diversify as Graham suggested, by buying dozens of companies.  The first damn thing I’d bought went bust!  Still, I think I learned something from it.

Look for financial robustness : Value shares are cheap for a reason.  It may be poor earnings, poor reputation, poor sector, debt, looming bankruptcy, there’s always something that’s not working out.  My solution to this was to focus more on the structure and strength of the balance sheet rather than just the price to book ratio, so that I would buy companies that are better able to ride out their current storm.  Of course Graham was almost a century ahead of me with this via his ‘net net’ idea which – almost – automatically ensures good liquidity and low debt, two key aspects of balance sheet strength.  I still don’t focus on earnings since they can be very volatile and there is research to suggest that better capital gains are had from companies which are currently making a loss.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

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