As I have said in the past. In these newsletters I share with you what 20 years of equity investment have taught me – sometimes at considerable cost. 

I this issue I am going to tell you about an investment mistake I made. One from which you can learn a valuable lesson and prevent you from losing money the way I did.

I was going to tell you about two disastrous investments but will leave it at one today as the other is a longer story with larger losses.

I can only stand so much embarrassment at a time.

The lesson is about my investment in a small UK retailer of upholstered furniture, called SCS Upholstery (“SCS”).

 

Don’t try to look it up as the company is not listed any more. The business was sold to a private equity company and the shareholders received nothing.

I had my eye on SCS for some time, but got really interested when a profit warning by a competitor knocked the share price down 54%.

I got even more interested when I read that a month earlier directors bought a total of 524,802 shares at a substantially higher price.

So on Thursday 10 January 2008 I bought shares in SCS at 41p.

I knew the company had benefitted greatly from the property bubble in the UK but at a price to earnings ratio of 2.5 times July 2007 earnings and 1.2 times 2006 earnings it was too cheap to ignore.

The company also had no debt and cash equal to 46% of equity.

Luckily I was wary of the impact of the property bubble and I invested only half the normal amount I invest per company. Little did I know that in the next six months the full force of the credit crisis and deflating of the UK housing bubble would hit the company.

On March 26, 2008 SCS released their interim results (Aug 2007 to Jan 2008) which said sales were down 13%. And due to margins declines the company made a trading loss of £8.8m compared to a profit of £3.3m the previous year. The dividend was also cancelled.

Because the results were not as bad as the disaster everyone expected, the share price increased to 62p the next month.

Selling at this price would have given me a nice profit of 51% but I didn’t sell. After all, on a price to earnings ratio of only 3.8 times 2007 profits and only 1.8 times 2006 profits I thought the company was still undervalued.

If only I knew what was going to happen next…

The news that knocked the company flat on its back was the 11 June announcement that a credit insurance company has cancelled its credit insurance for SCS.

A quick word on why credit insurance is important.

The suppliers to SCS (sofa manufacturers) buys credit insurance to ensure that they are paid by SCS. If SCS cannot pay them the insurance company will. This means that SCS can finance itself through its suppliers by only paying them after the sofas have been sold.
 
With credit insurance cancelled SCS either had to pay cash for their sofas or soon after delivery. SCS simply did not have the funds to do so. Even though they had no debt and cash on their balance sheet.

From there it went downhill fast.


Have you signed up for my free weekly newsletter "Investing that makes sense" yet?

Sign up now and receive articles like this in your inbox weekly.

And if you sign up now you will also receive a 10 page free bonus report – Enhanced Checklist for Value Investors – with over 30 proven checklist items to improve your investment returns.

 

I respect your privacy – Privacy Policy 

The share price dropped 62% to 11p.

I lost my confidence in the company and on 18 and 19 June 2008 sold 62% of my shareholding at 11p a loss of 73%.

The company tried to raise funding to make up for cancelled credit insurance but was unsuccessful and on 23 June 2008 the shares were suspended.

On July 3 the business was sold to Sun Capital Partners, the listing cancelled and the company liquidated.

Why I did not sell everything when I finally decided to sell I can’t remember. I may have thought that I should get part of my money out but still leave a bit in the company to recover my loss. Even at a 73% loss my remaining investment was still real money I could do better things with than watch it disappear into thin air.

The reason I’m telling you this is we all make mistakes. And making a mistake is also not a problem as long as you learn from it and take measures not repeat it.

So what can you learn from my experience?

Firstly irrespective of how large the loss on an investment is, it is never too late to sell. The money you have invested is still real money.

Secondly after this experience I developed strict stop loss and trailing stop loss rules which I follow very strictly. You can read more about how it works in the article titled Never mind what to buy do you know when to sell?

Your loss avoiding analyst