Sunday, September 23, 2007

Investment Mistakes Part 8 – Buying into a company whose business I did not understand

This can be said to be my second-last mistake of commission (thus far), my last probably being Global Voice once I have sold it off. The company in question is United Test & Assembly Centre (UTAC), a semi-conductor chip testing company similar to Stats Chippac and Chartered Semi-conductor. I had purchased UTAC on June 9, 2006 based on a friend’s rough TA guide (not considering fundamental characteristics – another mistake). According to him, he had identified a “support line” for UTAC and I also did some basic preliminary research on the company and found that it had 11 quarters of consecutive earnings and revenue growth. Strangely enough, the price had retreated to my buy price of 77 cents per share even though the prospects of the company seemed very good. It acquired a subsidiary in Thailand which it renamed UTAC Thailand and this helped to boost capacity further, creating economies of scale.

This is the only company in which I have made a profit from after selling but which I still classify as a mistake. This was because the capital gain was made from pure luck and a bull market, rather than based on proper research and fundamental considerations. After the Feb 2007 slump, I subsequently sold UTAC off on February 23, 2007 at 90 cents per share, netting a 15% gain over 8 months. This was about 1.5 weeks after I made my value purchased of Swiber (on Feb 14, 2007) after they secured a record LOI of US$146.6 million from Brunei Shell. It was a process of divesting my speculative companies and concentrating on value investments such as Boustead, Ezra and Swiber.

So what was actually wrong with UTAC, you may ask ? Technically speaking, nothing was “wrong” with the company in the sense that the company was doing fine; but the nagging thing about it was that its revenues and profitability could not be predicted with certainty, as the industry was cyclical and volatile by nature. This led to problems in terms of estimating future earnings and revenue, as the visibility was not present. Though there was a glut of information about the use of DRAM and about Korea’s Hynix expanding (plus a thousand and one other little bits and pieces of “related” information), this still did not help to accurately portray a picture of confidence for the company. This is one reason why the companies I invest in have a sustainable order book and good earnings visibility in the next 2-3 years (something different from the way Buffett invests, as he looks for companies with strong franchises and wide economic moats). More on this method in a future posting.

Besides the fact that the industry was competitive, margins were thin and future demand was uncertain, there was also the problem of complicated jargon relating to the semi-conductor industry which got me all boggled ! In UTAC’s quarterly review, there were a lot of technical terms used for various aspects of their operations and I was unable to determine the financial impact of these moves as I had limited knowledge and understanding of the industry as well as jargon. This caused further problems in trying to decipher what the future prospects of the company were like and whether it would be able to retain a certain competitive edge in future. It turns out that UTAC did not manage to continue their increasing profitability and suffered a drop because of UTAC Thailand’s slower start-up. Eventually, they were bought over for S$1.10 per share.

The lesson to be learnt here is that one should not invest in something which one does not fully understand, and this includes companies which are in fast-paced and ever-changing industries in which future demand and prospects cannot be ascertained confidently. In this way, we invest within our circle of competence and ensure that there are no unpleasant “surprises” which will crop up to cause our investment to stumble. Also, do not forget to buy with a wider margin of safety for investments which you do not 100% understand, in order to build a better safety cushion in case something goes wrong.

Note: This is my last posting on mistakes of commission; future postings on investment mistakes will focus more on mistakes of omission which have resulted in opportunity losses.

2 comments:

Anonymous said...

Hi MW

I totally agree with you that we should not invest in companies we do not fully understand. But similarly, we should not let our guard down and invest blindly just because we think we know more about a certain industry or company. For eg, my Chemistry background should make the understanding of companies like Hyflux, Sino-Enviro, China Energy etc easier than other fellow investors but there is much more to these companies than chemistry! It's still better to assume nothing and find out as much as you possibly can before ploughing your hard earned money into any company. Just my 2cts...

musicwhiz said...

Yep, I agree. It does not mean you should invest just because you are familiar with a particular industry or technology, because business conditions dictate profitability after all and sometimes it can be very hard to achieve consistent earnings and revenue growth.

Good luck !

musicwhiz