Although we live for the successes, the disasters are far more educational.
Some investors like to dwell on successes. I, however, prefer to dwell on disasters. It's not because I'm a masochist. It's because I learn more from disasters.
The successes, after all, are easy; they just go up and up. Disasters, on the other hand, contain dark warnings and salutary lessons.
Consider Invox
(LSE: INX)
. This is a company whose financial ratios once looked superb. In 2004 its operating margin was 45%, which is beyond the wildest dreams of most companies. The annual report for 2004 promised growth and even better results. In February 2004, the share price hit a high of 420p.
Then the price started to fall. This put the price-earnings and price-cashflow ratios into single figures, making Invox look like excellent value. Many people were seduced by this seeming cheapness, me included. I bought shares.
In 2005, Invox bought Brightview, an Internet service provider, which included the well-regarded MadAsAFish brand name. Invox's interim report said trading was "encouraging".
Then things started going awry. The board decided that they had paid too much for Brightview and wrote down its book value. A side-effect of this was that they didn't have the reserves to pay a dividend. A director left.
A few months later another director left.
A year later the company announced results showing that the core business had collapsed and that Brightview wasn't nearly as profitable as they thought it would be. The Chairman announced he would be leaving as well.
I sold my shareholding figuring that the value of the ISP, now the only valuable part of the business, was fully reflected in the share price. I'd lost some 80% of the capital invested. Ouch!
In this last week the share price hit a low of 15p, which represents a decline of 96% from the high.
So what had gone wrong, when, a few months ago, the financial ratios seemed to stack up so well? The story of Invox contains at least two lessons.
Acquisitions
When it bought Brightview, Invox paid well over the odds for a business that the directors clearly didn't understand. Acquisitions are known to be value destroyers, in this, the directors of Invox excelled themselves.
Lesson:Look at any acquisition carefully and form a view. If a company makes a rubbish acquisition, avoid like the plague
Business model
Invox's core business is called 'home gaming'. This involves offering users prizes if they ring a premium-rate phone number. The public tried this once, perhaps twice, and didn't like it. The business therefore collapsed.
Whilst I don't understand why people would ring premium-rate numbers in the hope of winning prizes, I also don't understand why people buy that acidic, sickly-sweet, brown fizzy water, known as Coca-Cola. Furthermore, I don't understand why they keep on buying it. I think it's horrid. And, because I don't understand why people choose to buy or not to buy a certain product, I try not to make judgements about the merits of a company's products.
There is, however, a difference between Coca-Cola and Invox. Coca-Cola has a product that has been proven to sell again and again for many decades. Invox's business model was only a few years old.
Lesson:Beware of untested and unproven business models.
I'll be taking these lessons to heart, in an effort to make better investment decisions in the future. Hopefully, there won't be too many of them.
