Fool's Eye View

[ February 8, 2000 ]

Passing By The Mortuary

By Maynard Paton (TMFMayn)

Carburton Street, London -- I'll begin with a comment from Warren Buffett. There is an obvious implication for investors within the remark.

"You become a better doctor if you pass by the mortuary once in a while."

One company that was recently rushed into intensive care, but was found "dead on arrival" was Versailles (LSE: VLL). The company now lies in the corporate mortuary, for all investors to inspect.

The rather sorry tale of Versailles has been well-documented in the press already. Inapickle gives a rundown on the spectacular fall from grace in this post. In a nutshell, a rapidly growing trade-finance company, worth over £600m, was found to be a complete sham. The "business" was largely a merry-go-round of invoices from numerous Caribbean businesses controlled by the Versailles Finance Director. When investigating the company, PricewaterhouseCoopers commented: "There would appear to have been a complex, extensive and long-running fraud inside the company of a very material nature."

Although the investigation will go on, and no doubt more revelations will come to light, Versailles shareholders wrote off their investment long ago. The final nail in the coffin comes tomorrow, as AFX news solemnly reports:

"FTSE International said following the appointment of receivers at Versailles Group plc, the company will be removed from the FTSE 250. The stock will be re-listed at 250 pence on Wednesday 9 February at the suspension price of 250 pence and adjusted to 0 pence in order to effect its exit from the second-tier index."

So what can be learned from the Versailles post-mortem? I won't delve again into trying to "spot the fraud", and whether any shrouded tell-tale signs could be taken on board when looking into other companies. Instead, I think the Versailles episode does highlight the breaking of a couple of sound investment principles by Foolish investors. A re-emphasis of a few straightforward rules could be in order.

Know What You Own

Would you buy a second hand car without first seeing it? Or book a holiday, without reading the brochure? Of course not. A private investor can spend a lot of effort considering their next motor or overseas jaunt. But shares can be different. Sometimes it is the "mystique" factor of an investment that appeals.

Why? Because it is more exciting. Forget about buying shares in your employer, where you're doing overtime to fulfil demand for a new product. Instead, some investors do like to own shares in an obscure mining company operating in Darkest Peru. The small chance of a fantastic financial result always, it seems, outweighs the certainty of a good financial result.

Basic questions do go unanswered when investors are blinded by potential share price gains. Can you describe what the company does? Would you be able to write a 100-word synopsis on its business? You should be able to.

In term of Versailles, I do think a lot of former shareholders had little true understanding of what the company did. Certainly from the Versailles message board, there was some confusion and hesitation in this respect. Only anquetil in this post gives a description of the Versailles business. Compare the Versailles board with that of ARM Holdings (LSE: ARM), where every other message appears to go into great detail about the advantages of their microchips.

There is no more basic rule in investment than "Know what you own". If you own shares in an unfamiliar company with an incomprehensible business, how do you know if their products are competitive? How do you know when an opponent supersedes your company's offering? In essence, how do you know what is going on in the business that you part-own? And if you can't answer that question, how on earth can you be sure that your company will be increasing its profits well into the future?

Visibility

Not only should a Foolish investor understand the business he or she is buying into, there are a few other straightforward questions that should be asked. Have you actually used any of the products the company manufactures, or the services the company provides? If not, do you know anybody who has? And are the products or services any good?

Part of the problem for Versailles shareholders was the lack of "visibility". It was purely a business-to-business operation, where the ordinary private investor would have little information and insight to answer the aforementioned questions.

Contrast Versailles to Vodafone AirTouch (LSE: VOD) PizzaExpress (LSE: PIZ), or Manchester United (LSE: MNU). With Versailles, there was little "tangibility". You couldn't buy a mobile phone from them, eat at their restaurants or watch them from the terraces. Foolish investors would have little "feeling" for how business was going at Versailles, and no way of independently judging the performance of the company. How could they? Without the separate view of how a business is performing, shareholders must rely on the company for information. Apart from speaking to directors, who usually paint a positive picture anyway, shareholders can get left in the dark over trading.

When there is tangibility, when investors can actually see for themselves how their business is operating, it brings so much more added comfort. Using the mobile phone, eating at the restaurant or watching the team, and then assessing their strengths of the products, gives a greater understanding of the company and the industry the company operates in. There is a lot to be said for this "kicking the tyres" approach when researching your next investment.

To put the visibility factor into context, take the Versailles clientele. Their fraud was perpetuated by the creation of fictional customers -- only 15% of the supposed Versailles clients are now said to have actually existed. To a certain extent, you only had Versailles' word on the size of their customer base. On the other hand, if Manchester United were ever to suffer low attendances, a shareholder would be able to see for themselves the dwindling number of supporters. It would be impossible for Manchester United to then account for full houses without a raised eyebrow.

Beware the Tipster

Versailles was a favourite for the share tipster. Indeed, it still remains so, with one newsletter still highlighting on their promotional literature the fact that it had tipped the company last year. Maybe we can excuse this particular publication, as it pays most attention to charts, rather than any fundamentals...

There is a basic problem with tipsters. They have to tip. To keep interest in their publication, new tips have to be generated. Thus, with a constant need of new suggestions, the research can go awry. If you have to suggest a new company each week to keep your readers, or editor, happy, you're bound to suffer losers. A sad fact from the Versailles message board is the mention of investment decisions based upon remarks from various tip sheets.

So, if you subscribe to a newsletter, you would expect at least some research. And not just the regurgitated contents of the annual report. I could be wrong, as I don't read any of the tip sheets mentioned on the message board, but I'd be surprised if any visited Versailles and asked the pertinent questions. Did they "kick the tyres", before they dished out the tip?

The story of Versailles is extraordinary. It was a long-running fraud that fooled everyone. It wasn't the first of such cases, nor will it be the last. But hopefully, Foolish readers can take on board some of the basic principles of investment. That is, to understand the business and being able to independently judge the product or service, and not totally rely on others to do your research.

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Related Links
• Versailles -- Accounting Concerns