The heatwave and hose pipe bans have been a recent reminder of the old investing adage about water usage – don’t cut the flowers to water the weeds. It’s all too tempting to trim positions that have performed well to average down in underperforming businesses. Why do we do this? It’s just psychologically easier for the human brain to handle selling a winner than crystallising a loss. The thought process being you think you’re getting a better bargain rather than acknowledging you made an investment that didn’t work out and you need to yank it from the portfolio. If you cut the flowers too early, you’ve enjoyed some of the splendour on offer but can miss out on the blooming marvellous returns.
There’s no denying I have been guilty of giving companies ‘one more quarter’ to prove themselves, but with the market now providing so much opportunity, a couple of management teams had their last chance quarter and have been turfed out. Weeding is essential and is incredibly satisfying, knowing you’ve done the mental hard work and are left only with the view of blossoming portfolio potential. So, what’s been weeded out and what’s been planted in their place?
The weeds
3 companies where I’ve taken a small loss, a larger loss and made a c.3x money gain. The investment resulting in a substantial gain is still so cheap that I can’t really believe that I have sold it, but the management have become increasingly incoherent, and I’ve just lost conviction in them while being able to take advantage of a short-term technical factor to sell into a rising price. No doubt the price will now double, or the company will get taken out at a huge premium, but sometimes a profit is a profit, and the process matters for consistent success. The smaller loss is from a business whose growth is now really starting to accelerate, but at margins much lower than originally anticipated and the value proposition no longer looks as compelling. The larger loss is from a business with great potential, particularly given energy markets today, but I saw the capital allocation warnings signs a long time ago and should have sold much earlier as it become obvious that the jockey was wasting the potential of the thoroughbred he was seated on.
The plantings
The released funds have been partially re-deployed in the last 2 published MHM ideas, which are essentially monopoly / oligopoly operators with secular market tailwinds trading well below their fundamental value. I will aim to add further to those positions as long-term cornerstones of the portfolio. In addition, I have added to a position that in hindsight I entered far too early, but the management have been impressive in the actions they have taken to position for the long term at the cost of short-term pain and the business is now poised to inflect through to profitability in the next 12 months. The real kicker – it is currently trading at a negative Enterprise Value (i.e. the market cap is less than the cash on hand) with a proven management team, strong insider ownership and more than enough cash runway headroom. Its market cap is now so small that the company is so far off the radar that the first hint of positive news could see it quickly return to a realistic valuation of multiples its current price. This, along with 2 other businesses that I am currently working on, and which are likely to be the upcoming published MHM ideas, will be the focus of fund re-deployment in the near term.
Positioned for variable market climes
With the relatively quiet summer market coming to a close, I feel that my personal portfolio is my best ever concentration of ideas. A combination of ‘forever holds’ that the market has gifted at wonderful prices and potential multi-bagger positions with upcoming positive catalysts that can withstand a long, cold winter and ensure a strong bloom in a warm market climate. Many are already available as MHM published ideas, and we look forward to sharing others over the coming months.
Nick Hargrave (MHM Founder & CEO)
