For years, Provident Financial (LSE: PFG) was an investor darling thanks to consistent revenue, profit and dividend growth. There was also its leading position in the massive market making loans to relatively under-banked subprime borrowers.
But its tremendous record of growth came to a screeching halt in early 2017 as the bank issued an out-of-the-blue profit warning, leaving bullish investors, like myself, wrong footed. This, of course, is part and parcel of investing, and should be treated as an opportunity to learn where a thesis went wrong and how such an issue can be avoided again in the future.
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For Provident, the issue was management’s move to end its relationship with its army of self-employed agents who covered a certain geographic area where they would have relationships with customers to whom they would extend credit and collect repayments. In their place, management sought to employ a percentage of these workers on an in-house basis and use a new computer system to improve the lending process and lessen regulatory risks from using contract employees.
On the face of it, this move made sense to investors like myself. However, things clearly went wrong when the new computer system proved to be not up to scratch and, more critically, many self-employed agents decided to not come in-house. That left Provident with large areas where no new loans were being made and existing loan repayments weren’t being collected.
What did I learn from this? First off, don’t underestimate the potential effects from any change to a company’s core business, even if it’s one that seems to make sense such as bringing field loan officers in-house.
Second is to make a more concerted effort to listen to what the employees of a firm are saying. In Provident’s case, there were plenty of agents complaining publicly about the changes before management was forced to issue its profit warning.
Another stock I was very wrong about was Safestyle UK (LSE: SFE), a large PVC window and door replacement manufacturer and retailer. The company’s first few years as a public entity went smoothly as it reported consistent sales and profit growth on the back of growing share of its highly fragmented market.
But this came to an abrupt halt last year with a shock profit warning. That turned out to be down to a rival operation setting up shop in Safestyle’s own backyard with a similar business model, branding and even many former employees.
What did I get wrong here? Well, the big problem was overestimating just how much of a moat Safestyle had to ward off competitors. The new competitor proved adept at producing and selling its products at a similar price point to Safestyle, which I had thought highly unlikely given the company’s vertically integrated business model.
There were several important lessons learned from this one. Ensure as much as possible a company’s competitive advantage is deep and lasting; pay closer attention to whether customer decisions are driven more by price or quality; and to take a look at a sector’s history, which could have tipped me off to previous problems in Safestyle’s market.