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Learning from investment failure

Pathfinder commentary: John Berry looks a three epic investment failures and outlines the lessons investors can learn from them.

Tuesday, April 8th 2014, 6:09PM

by Pathfinder Asset Management

We all like to hear amazing investment stories – risks taken that are rewarded with staggering returns.  Take the example of David Choe, an American painter, muralist and graffiti artist.  He was 29 years old in 2005 when Facebook asked him to paint a mural in its Palo Alto office.  Short on revenue, Facebook offered him payment by a small shareholding instead of $60,000 in cash. 

Although Mr Choe described Facebook’s business model as “ridiculous and pointless” he also liked to take a wager – so accepted the shares.  Remarkably, at the time of float in 2012 his tiny Facebook shareholding was worth US$200m! 

While we like success stories, we often learn more from stories of failure.  Below are three true (and tragic) stories that generated massive losses for investors.  What, if any, lessons can we draw from them?

1 – Ratner Group

Ratner Group, a jewellery business formed in 1949, grew into a large listed company.  In fact by the early 1990s it had a 50% market share in the UK. 

In a speech to a UK business conference in 1991 the company’s CEO (George Ratner) made what some describe as the “most famous gaffe in 20th Century British business”.  Reviewing the firm’s business model he described one product sold in its high street stores as “total crap” and advised a pair of their earrings cost less than a prawn sandwich but didn’t last as long. 

Once reported in the media the company’s market capitalisation plunged by more than NZ$1.7 billion.  Three hundred stores were forced to close in 1992 as customers stayed away.  The company became immortalised by the saying “doing a Ratner” (meaning exercising very poor judgement), surviving only through a massive restructure (and name change).

Lessons for investors:  The value of a company can often be measured by the value of its brand.  Sometimes brands may appear on the balance sheet as “intangible assets” – but they are notoriously difficult to value.  Companies that recognise the importance of protecting their brand generally make better investments.  They can build stronger customer loyalty, may have better governance and are less likely to “do a Ratner”.  

2 – Apple Computers

Investment failures can include missing opportunities – an opportunity cost (lost profit) can be as real as a cash loss.  Take the example of Ronald Wayne, who is often described as the unluckiest guy in the world.  In 1976 he set up Apple Computers with Steve Jobs and Steve Wozniak.  But he soon had cold feet about his business partners and within weeks sold his 10% holding for a total of US$2,300.

In 1976 Apple was a start-up company with sales of US$176,000.  But with sales growth averaging 320% per annum over the next 6 years, its revenue was over US$1 billion by 1982.  Fast forward to 2014 and Apple’s sales have grown at a compounded rate averaging 58% per annum for 37 years.  From these numbers you’ll be guessing it was a large missed opportunity for Mr Wayne and his 10% holding.

This wasn’t your average missed opportunity – it was a spectacular miss.  What sold in 1976 for US$2,300 would now be worth US$47 billion. Despite living in a trailer park and not having a US$47 billion fortune, he has no regrets whatsoever.  He seems well educated and smart – but accepts the fact that Jobs and Wozniak weren’t a good fit in business for him.

Lessons for investors:    Two great lessons from this story.  Firstly, as we all know, sometimes a small high risk business in the technology space can make it very big very fast.   The investment pay off can be huge for private equity investors willing to take the significant risks.  Secondly,  when you are faced by having sold too soon or electing not to invest in something that turns big, adopt Ronald Wayne’s approach and move on without too much regret.

3 - Kodak

In 1975 the first digital camera was made at an experimental lab of Eastman Kodak.  The company quickly identified the potential of this invention – but also faced a huge dilemma.  Kodak had an 89% market share of photographic film in the US – why would it want to promote a new device that would so clearly cannibalise its existing product? 

The digital camera would make the entire existing business obsolete.

So Kodak kept the discovery under wraps.  But by the mid-1990s the technology was widely available – by now competitors like Canon were producing digital cameras and owned this new market.  Kodak joined the party too late.  Once a major US corporate in the Dow Jones index with a share price of US$75 (in the late 1990s) it was bankrupt in 2012.

Lessons for investors:   When investing in companies be sure to understand their culture.  Do they embrace change?  Do they spend on R&D to improve their product? Do they listen to their customers?  A company that does none of these things and has a culture of resisting change is unlikely to be a flourishing long term investment.

 

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