Here at the Fool, we are fans of buying promising businesses for the long term. That said, we also recognise that part of becoming a better investor rests on being able to acknowledge stock-picking mistakes and on learning from them.
Today, I’m going to explain why I’ve recently jettisoned two of the worst performing stocks from my portfolio — advanced wafer products supplier IQE (LSE: IQE) and sports nutrition company Science in Sport (LSE: SIS).
There’s simply no hiding from the fact that shares in Cardiff-based IQE are still way down on the highs reached back in November 2017. Sixty percent down, to be precise.
Last week’s full-year results, while never likely to be good, didn’t make for pleasant reading.
Revenue may have increased very slightly (1.1%) over 2018 to £156.3m but pre-tax profit dropped 43% to £14m following what CEO Dr Drew Nelson described as “a very difficult and challenging year“.
Ordinarily, I wouldn’t sell a holding based on a fairly short period of underperformance. With IQE, though, I can’t see things improving any time soon.
Perhaps my biggest worry is the dwindling amount of cash on the balance sheet. Net funds fell from £45.6m to £20.8m over 2018 — a 54.4% decrease — while capital investment increased almost 22% from £34.8m to £42.4m.
Some may argue that IQE’s growth credentials fully justify this heavy spending. That may be true but I don’t see a halt to the latter any time soon.
There’s another nagging concern. Right now, IQE is still one of the most popular shares on the London Stock Exchange among short sellers (those betting on the share price to fall). Only strugglers like Debenhams and Metro Bank are attracting more attention. The fact that these positions haven’t been closed post results suggests that there could be worse news ahead.
Of course, short sellers don’t always get things right. Given that they technically have a lot more to lose compared to your typical investor, however, their ongoing bearishness certainly warrants attention.
IQE could end up doing very well (there’s always a chance that I’m exiting at the worst possible time) Nevertheless, I can’t help but think there are less risky destinations for my remaining capital, especially as the shares still trade on 21 times earnings.
And if you’re going to wait for a recovery, there’s an argument that you should at least be compensated for your patience.
Running to stand still
Science in Sport is another portfolio laggard that I’ve dispensed with. This business has been a disappointing (but mercifully small) investment, even if recent trading has been encouraging.
Group revenue jumped 37% to £21.3m in 2018. Gross profit also rose from £9.3m to £12m, supported by a small contribution from the newly-acquired PhD Nutrition brand.
The problem is that the company is still loss-making on an underlying basis. Moreover, these losses are increasing (£2.5m in 2018 compared £1.7m in 2017) as a result of ongoing investment in “brand awareness, e-commerce, and international expansion“.
The company may be growing at a faster rate than competitors but it’s burning through a lot of money in doing so. The cash pile more than halved over 2018 (from £16.6m to £8m).
Again, if you’re patient enough, this could be a rewarding investment. However, with another equity raise looking likely (although not guaranteed), I’m happy to walk away for the time being and focus on other growth-focused opportunities.
Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.