Section Items
Short Term Holding
Slightly Off Topic

Share Trading - Why Researching Companies Is A Fallacy.

Go onto any of the share forums and you will see "dyor" or Do You Own Research, realistically I believe that this is in fact impossible.

Think Enron, Worldcom, Freddie Mac, Fannie May, American Insurance Group, Parmalat, Lehman Brothers.....

After a certain amount of research you get to the point where you are collecting data that is purporting to be information, that is to say it may be true but you can not reliably attach any meaning to it.

.. and of course you are relying on that information to be complete and accurate, most recently there was Patisserie Valerie (CAKE).

Why Can't I Research A Company?

I was chatting with someone in the pub who had bought shares, he bought £3K worth, lost most of his money and was insistent that he had "researched" the company properly.

As a small investor it is impossible to research companies beyond the superficial as you simply don't have enough access to the people in the business to know the truth behind the accounts.

There are some common absurdities in accounts that you learn to ignore, for example most companies include Goodwill in their assets. Goodwill does have a value, if you wanted to start a burger restaurant, then your are more likely to succeed as a McDonalds than you are as an independent. Commons sense tells you that the McDonalds name has value or Goodwill.

However the accountants get involved and Goodwill ends up with astronomical values. Looking at the accounts of real company;

Property, Plant & Equipment:£2,191M (about 2 billion pounds)
Goodwill:£729M (about seven hundred million pounds)

Properly drawn up and fully audited accounts are allowed to say that value of people liking the business is a bit over seven hundred million pounds. This is about a third of the value of the real things that they own, like the buildings and machines.

Whilst this is a well known area to check, it does highlight how hard accounts are to read.

Imagine a company that makes high value items such as oil rigs, which has £200M of Work In Progress.
  • The management may have slipped up and the initial profit estimates are wrong,

  • Or it won't be finished on time incurring penalties,

  • Or one of the clients is suspected of being in trouble so will not complete the purchase.
Or what about pub groups such as Punch (LON:PUB) or (LON:ETI) Enterprise Inns, a huge part of their assets are the pub buildings, but there is no way that you can know how accurately these are valued.

Given that many business have loans which are restricted to a percentage of the value of their assets or earning an accidental or overly optimistic valuation could lead to violations of the covenants forcing a refinancing of the debt.

Then you get to plain incompetence, look at Conviviality and an overlooked £30million tax bill!

Finally you get to plain and simple dishonesty, do an Internet search on Paramalat and see how they invented a bank account with $4.9 billion dollars in it!

You may think that you can supplement your understanding by looking at analysts target share prices, yet they often show a 20% or 30% upside from the current market price and within a few weeks of these prices being set the company does a rights issue halving the shares value!

This happens a lot more often that you might expect and occurs because like the private investor, the analyst doesn't have access to sufficient information.

A Real Example - Provident Financial plc

Provident Financial are the doorstep lending company that has been around "forever".

Although they have expended to offer on line loans and credit cards they are the sort of company that you would expect to be very predictable with a consistent share price and any changes well known the market.

Yet their share price went from 3,000p which it had been trading at for a couple of years to 589p to then stabilise at around 900p

The reason is that they changed their sales model from self employed agents to employees and the FCA having concerns about an optional service on their credit card.

They first announced (Jul 2017) the credit card issue and significant reduction in profits as there were issues with the new collection model. The price dropped from about 3,000p to about 2,000p

They then announced (Aug 2017) that reduction in profits was much greater than was reported in July and on the day the share price dropped down to about 450p before recovering a bit.