Fishing Republic, Pattiserie and Smithson Trust

Fishing Republic (FISH) shares have been suspended and it looks like it’s run out of money with folks unwilling to finance it further. A new CEO was about to join but now is not. I have never held shares in this company so I just had a quick look at the history of its listing on the AIM market.

It listed in 2015 with an initial market cap of £2.7 million – yes it always was a small business. The share price rose as high as 46p as it went for growth, but was 5.22p when suspended. The last interim results looked terrible – loss of £2.5 million on revenue of £3.4 million. The company suggested its problems were down to competitive pressures and tough market conditions, but it looks to me more a simple case of mismanagement. Was there really a big market for fishing tackle where fishing enthusiasts would pay good money for such kit in any case?

This is probably going to be just the latest poor-quality business, or ones with unrealistic ambitions, to disappear from the AIM market which has been shrinking. It’s now down to 937 companies when it was nearly 1,700 in 2007. That near halving in the number of companies has probably improved the overall quality of the market with an emphasis on larger companies now. That’s probably good for investors.

Hindsight always makes the problems look obvious of course. In the case of Patisserie Holdings (CAKE) I have seen it said that the cakes were boring, the shops often empty and it seemed odd that they could make good profits in such a competitive sector. The first two I discounted because that was not my experience of visiting their cafes (I always try to sample the wares of companies I invest in). As regards the latter issue, we await more information, but Whitbread have just flogged off their Costa coffee chain for an enterprise value of £3.9 billion, representing a multiple of 16.4 times FY18 EBITDA. That’s a rich price for a similar business in a competitive sector with no obvious barriers to entry is it not?

Shareholders in Patisserie Holdings can attend the General Meeting at 9.0 am on the 1st November to approve the second share placing, and ask some questions. That’s a very inconvenient time for many shareholders and is certainly not “best practice”.

The UK stock market seems to have stabilised somewhat after recovery in the US. It’s always worth having a quick look at the S&P 500 to see how it is trending if you wish to know where the UK market is going to go. This should bode well for the launch of the Smithson Investment Trust which raised its fund-raising limit and will be the biggest ever UK investment trust launch at £822 million. Dealings will commence on the 19th October, but best to wait and see how it performs longer-term in my view. There’s obviously some short-term enthusiasm for another fund from the Terry Smith stable regardless of having no track record.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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CAKE (Patisserie), Foresight 4 VCT AGM, Payment Companies and Dunelm

More bad news from Patisserie Holdings (CAKE) today – well at least you can’t say the directors are not keeping you informed about their dire situation which is not always the case in such circumstances.

Yesterday the company announced that its major operating company had received a winding-up petition from HMRC, of which the directors had only recently become aware. Today the company said after further investigation the board has reached the conclusion that without an “immediate injection of capital, the Directors are of the view that there is no scope for the business to continue trading in its current form”.

The directors could possibly try to do a quick placing at a deep discount no doubt, borrow a pile of cash at extortionate rates or they could put it into administration. The big risk is that Exec Chairman Luke Johnson will put it through a pre-pack administration. I hope he does not because that won’t do his reputation any good at all. He needs to try and engineer some sensible solution if his reputation in the financial world is to remain intact. That is particularly so after he wrote an article for the Times in September on “a beginner’s guide to tried and tested swindles” suggesting how you can spot them. Clearly he was not taking his own advice. Whatever happens, the outlook for existing shareholders does not look good.

As another commentator said, the Treasury should not reduce the generous tax reliefs on AIM companies because they need to realise that it is a risky market.

But there was some good news on cake yesterday when the Supreme Court decided after all in an appeal from the lower courts that a cakemaker can refuse to bake cakes where the proposed wording in the icing is objectionable to them. A victory for common sense and liberty.

Today I attended the Annual General Meeting of Foresight 4 VCT (FTF). There is one advantage to owning VCT shares. They barely move when the stock market is otherwise in panic mode. They are one of the few “counter-cyclical” investments to public companies as they invest in private equity. There are some disadvantages of course. Illiquidity in the shares, and often disappointing long-term performance as in Foresight 4. But it may be improving.

I won’t cover the meeting in detail but there were a couple of interesting items in fund manager Russell Healey’s presentation. He mentioned they are still having problems with long delays on HMRC pre-approval of new qualifying investments – can still delay deals for a few months it seems. More representations are being made on this.

He also covered the performance of their top few investments. Datapath, the largest, was valued down because EBITDA fell but revenue is still growing and the fall in profits arose from more product development costs. Ixaris, the second largest, is growing strongly (I knew this because I have a direct holding in it and had just read the December 2017 accounts they filed at Companies House). From my recollection that’s the first year they have made a profit since founding 16 years ago. Russell couldn’t remember how many funding rounds the company had launched – was it 6 or 7, and me neither. That’s venture capital in early stage companies for you – you have to be very patient.

However, in response to a question from VCT shareholder Tim Grattan it was disclosed that VISA are tightening up on the rules regarding pre-payment cards. This might affect a significant part of Ixaris’s business. I suspect it will also affect many other pre-payment card offerings by payment companies, some of whom are listed. Particularly those that are using them to enable payments into gaming companies which Visa does not like.

It was another bad day in the market today, although Dunelm (DNLM) picked up after a very positive trading statement with good like-for-like figures. They are moving aggressively into on-line sales but their physical stores also seem to be producing positive figures so perhaps big retail sheds are still viable. They are not in the High Street of course.

While the market is gyrating I am doing the usual in such circumstances having been through past crashes. Will the market continue to go down, or bounce back up? Nobody knows. So I tend to follow the trend. But I also clear out the duds from my portfolio when the market declines – at least that way I can realise some capital gains losses and reinvest the cash in other shares that are now cheaper. I also look carefully at those stocks that seem to be wildly over-valued on fundamentals – those I sell. But those that suddenly have become cheap on fundamentals I buy, or buy more of. In essence I am not of the “hide under the sheets” mentality in the circumstances of a market rout as some are. But neither do I panic and dump shares wholesale. This looks like a short-term market correction to me at present, after shares (particularly in the USA) became adrift from fundamentals and ended up looking very expensive. But we shall no doubt see whether that is so in the new few days or weeks.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Worldwide Healthcare Trust AGM – But No Proxy Voting Form

Today I attended the Annual General Meeting of Worldwide Healthcare Trust (WWH) in London. This is an investment trust focused on a portfolio of worldwide pharmaceutical and biotechnology companies. It has a very good long-term track record, consistently beating its benchmark and is the top performer of all UK investment trusts measured since formation.

The fund manager is OrbiMed where Sam Isalay was the managing partner until recently when he departed under a cloud of sexual harassment claims. He also resigned from the board of the Trust at the same time and was replaced by Sven Borho who did the manager’s presentation this year. Sam Isalay was present at the meeting and asked a question. He also got a vote of thanks for his past work, prompted by the Chairman.

There were about 100 shareholders present including quite a number of institutional investors apparently by the cut of their suits and age, which is unusual.

I will summarise Sven’s talk in brief although it was particularly interesting. He said the recipe for success was still very much in place. The team is still in place even after the change of leadership. The trust was up 2.8% last year against a benchmark decline of 2.5%. The share price discount narrowed and it is now trading at a premium (now 0.8% according to the AIC).

Year to date (since March year end) the NAV is up 15.8%. The consistent out-performance seems to be down to stock-picking with a focus on small/mid cap companies.

Sven also said that it was strong year of scientific progress and mentioned in particular gene therapy, gene silencing and CAR-T work. He also discussed the progress on a cure for alzheimer’s disease at some length where real progress is being made. There have been many past failures in cures for that disease with billions of dollars being spent but there are 5.7 million patients needing treatment in the USA which is more than all cancer patients combined. There are several companies in clinical trials with phase 3 results due by 2020.

I might need a cure because this morning I had a “senior moment” and shut the garage door while my wife was backing her car out. Fortunately no damage done or I would not have heard the last of it.

Apparently the drug approval rate has increased substantially due to a change in management at the FDA who has changed the regulations to make it easier and cheaper to get approval for new drugs.

After about an hour of Sven’s presentation, which was rather long, we moved onto the formal business of the meeting.

One shareholder asked how much had the company borrowed? He also said he asked the same question last year and was still waiting for an answer. The simple answer he got was they are 117% invested, but as they use derivatives the full answer was more complex and I did not understand what was said – there is more clarity in the Annual Report. The shareholder was clearly not satisfied because he voted against the Chairman when it came to the vote.

I questioned what the impact would be of the announcement in the Annual Report that they would no longer be issuing proxy voting forms with their invites to the AGM. The Chairman referred me to the Company Secretary who could not give an answer. So I made it clear I objected to this change as it would be likely to discourage voting. As I said, I had already raised this issue with their Registrar’s Link Asset Services in an exchange of correspondence (see my previous blog post on this topic here: https://roliscon.blog/2018/07/23/voting-at-general-meetings-link-asset-services-and-centralnic/ ). Why did the Chairman not ask the audience at this meeting what they preferred? He declined to do so.

He also suggested there was not time to spend on this issue at which point I said he would have plenty of time if he had not set the start time of the AGM at 12.00 noon. This is a practice I have seen at other trust AGMs where after presentations there is little time left for questions before lunch is served. I think this is very bad practice.

Note if you don’t receive a paper proxy voting form in future, go here for one you can use at any General Meeting: https://www.roliscon.com/proxy-voting.html . If you think this is a retrograde step which will reduce voting by private shareholders from the already low level, please do complain about it to the Chairmen of companies and to Link Asset Services.

I did not have time to raise the issue of the Chairman having served on the board since 2007. This is contrary to the UK Corporate Governance Code, so that’s another reason why I will be voting against him next year. He got 6.6% against him on the proxy vote counts at this meeting.

Other than the issues mentioned above, this was a very informative meeting and well worth attending. As readers may be aware, I have suddenly taken an interest in the gene therapy area and this trust is one way into it. The manager, OrbiMed, also manage the Biotech Growth Trust which is more focused and somewhat smaller. It also trades at a significant discount at present but has underperformed its benchmark of late.

Postscript: there is an interesting article on the departure of Sam Isalay here on Citywire: http://citywire.co.uk/investment-trust-insider/news/fund-manager-accused-of-harassment-hits-out-over-exit/a1157479?

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Horizon Discovery – Ripe For Some Activism?

Horizon Discovery Group (HZD) announced their interim results this morning. Still not making any profits although the EBITDA losses improved “before exceptional items”, i.e. before depreciation and amortisation which they prefer to ignore.

As I mentioned in a previous blog post, this is one of my speculations in the field of gene biotechnology. In this mornings’ announcement the new CEO said: “In light of this rapid change, and since my appointment as CEO, we have taken the opportunity to refresh our five-year strategic plan. Horizon is uniquely positioned to capitalise on rapidly growing market demand through our scientific and commercial leadership. With limited direct competition, Horizon has strong prospects for growth and is moving swiftly to capitalise on these opportunities. Our goals remain ambitious:  to harness the power of the cell in order to be the ‘go to’ provider of IP-rich cell engineering solutions and to establish leadership positions in our key markets, based on a highly scalable and repeatable business model.”

Sounds like they are going to spend more cash, whereas I suggested previously that this is one company that might be nearing profitability in this sector. I also attended the last AGM of Horizon in June and it was clear to me then that this was a company that could be turned profitable very easily (see blog report here on that: https://roliscon.blog/2018/06/19/horizon-discovery-agm-and-chrysalis-vct/ ).

The company also received a tentative bid from Abcam not long ago which they rejected as undervaluing the business.

The interesting thing is that the FT reported today that activist investor ValueAct had acquired another 5% of the company (they already held 5%) from Woodford Investment Management. Between these two companies they now hold 28% of the shares. Although ValueAct may be one of the less aggressive activist investors, it does suggest that change might be afoot.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Lehman Collapse, Labour’s Employment Plans, Audit Reform Ideas and Oxford Biomedica

There was a highly amusing article in today’s FT by their journalist John Gapper explaining how he caused the financial crisis in 2008 by encouraging Hank Paulson, US Treasury Secretary, to resist the temptation to rescue Lehman Brothers. So now we know the culprit. Even more amusing was the report on the previous day that the administrators (PWC) of the UK subsidiary of Lehman expect to be left with a surplus of £5 billion. All the creditors are being paid in full.

Why did Lehman UK go bust then? They simply ran out of cash, i.e. they were cash flow insolvent at the time and could not settle payments of £3bn due on the day after their US parent collapsed. Just like Northern Rock where the assets were always more than the liabilities as also has been subsequently proven to be the case.

Perhaps it’s less amusing to some of the creditors of Lehman UK because many sold their claims at very large discounts to third parties rather than wait. Those that held on have been paid not just their debts but interest as well. So the moral is “don’t panic”.

Lehman’s administration is in some ways similar to the recent Beaufort case. Both done under special administration rules and requiring court hearings to sort out the mess. PWC were administrators for both and for Lehman’s are likely to collect fees of £1billion while employing 500 staff on the project. It may yet take another 10 ten years to finally wind up. Extraordinary events and extraordinary sums of money involved.

An editorial in the FT today supported reform of employment legislation as advocated by Labour’s John McDonnell recently. He proposed tackling the insecurity of the gig economy by giving normal employment rights to workers. I must say I agree with the FT editor and Mr McDonnell in that I consider that workers do have some rights that should be protected and the pendulum has swung too far towards a laissez-faire environment. This plays into the hands of socialists and those who wish to cause social unrest. Even the Archbishop of Canterbury suggested the gig economy was a “reincarnation of an ancient evil” and that it meant many companies don’t pay a living wage so employees rely on state welfare payments. A flexible workforce may give the country and some companies a competitive advantage but it takes away the security and dignity of employment if taken to extremes. The Conservative Government needs to tackle this problem if they wish to be certain of getting re-elected. If you have views on this debate, please add your comments to this blog.

Mr McDonnell also promoted the idea of paying a proportion of a company’s profits to employees – effectively giving them a share in the dividends paid out. That may be more controversial, particularly among shareholders. But I do not see that is daft either so long as it is not taken to extremes. After all some companies have done that already. For example I believe Boots the Chemists paid staff a bonus out of profits even when a public company.

Another revolutionary idea came from audit firm Grant Thornton. They suggest audit contracts should be awarded by a public body rather than by companies. This they propose would improve audit standards and potentially break the hold of the big four audit firms. I can see a few practical problems with this. What happens if companies don’t judge the quality of the work adequate. Could they veto reappointment for next year? Will companies be happy to pay the fees when they have no control over them. I don’t think nationalisation of the audit profession is a good idea in essence and there are better solutions to the recent audit problems that we have seen. But one Grant Thornton suggestion is worth taking up – namely that auditors should not be able to bid for advisory or consultancy work at the same company to which they provide audit services.

Oxford Biomedica (OXB) issued their interim results this morning (I hold the stock). They made a profit of £11.9 million on an EBITDA basis. OXB are in the gene/cell therapy market. What interests me is that there are some companies in that market, at the real cutting edge of biotechnology with revolutionary treatments for many diseases, that are suddenly making money or are about to do so. That’s often after years of losses. Horizon Discovery (HZD) which I also hold is another example. Investors Chronicle recently did a survey of similar such companies if you wish to research these businesses. It is clear that the long-hailed potential of cell and gene therapy is finally coming to fruition. I look forward with anticipation to having all my defective genes fixed but I suspect there will be other priorities in the short term particularly as the treatments can be enormously expensive at present.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Brexit, Abcam, Victoria and the Beaufort Case

Another bad day for my portfolio yesterday after a week of bad days last week when I was on holiday. Some of the problems relate to the rise in the pound based on suggestions by Michel Barnier that there might actually be a settlement of Brexit along the lines proposed by Theresa May. This has hit all the companies with lots of exports and investment trusts with big holdings in dollar investments that comprise much of my portfolio. But a really big hit yesterday was Abcam (ABC).

Abcam issued their preliminary results yesterday morning. When I first read it, it seemed to be much as expected. Adjusted earnings per share up 27.1%, dividend up 17.1% and broker forecasts generally met. The share price promptly headed downhill and dropped as much as 32%, which is the kind of drop you see on a major profit warning, before recovering to a drop of 15.2% at the end of the day.

I re-read the announcement more than once without being able to identify any major issues or hidden messages that could explain this drop. The announcement did mention more investment in the Oracle ERP system, in a new office and other costs but those projects were already known about. Indeed I covered them in the last blog post I wrote about the previous Abcam AGM where I was somewhat critical of the rising costs (see https://roliscon.blog/2017/11/15/abcam-agm-cambridge-cognition-ultra-electronics-wey-education-and-idox/ ). The Oracle project is clearly over-budget and running behind schedule. A lot of these costs are being capitalised so they disappear from the “adjusted” figures.

The killer to the share price appears to have been comments from Peel Hunt that the extra costs will reduce adjusted earnings by 9% based on reduced margins. The preliminary results announcement did suggest that the adjusted EBITDA margin would likely be 36% as against the 37.8% that was actually reported for last year. Revenue growth of 11% is expected for the current year so even at the reduced margin that still means profits will grow by about 5%. That implies only a slight reduction in adjusted e.p.s. on my calculations which implies a prospective p/e of about 34. That may be acceptable for such a high-quality company with an enviable track record (which is why it is one of my larger holdings) but perhaps investors suddenly realised that the previous rating was too high and vulnerable to a change of sentiment. That realisation seems to be affecting many highly rated go-go growth stocks at present.

The excessive IT project costs are of concern but if the management considered that such investment (£33 million to date) was necessary I think I’ll take their word on it for the present. At least the implementation of the remaining modules is being done on a phased approach which suggests some consideration has been given to controlling the costs in the short term.

I attended the AGM of another of my holdings yesterday – Victoria (VCP). They manufacture flooring products such as carpets, tiles, underlay and also distribute synthetic flooring products (I think that means laminates etc). There was a big bust-up at this company back in 2012 in which I was involved. The company was loss making at the time but some major shareholders decided they wanted a change or management and lined up Geoff Wilding who is now Executive Chairman. After an argument over his generous remuneration scheme and several general meetings, it was finally settled. After meeting Geoff I decided he knew more about the carpet business and what was wrong with the company than the previous management and therefore backed him – a wise decision as it turned out. Since then, with aggressive use of debt, he has done a great job of expanding the business by acquisition and this has driven the share price up from 25p to 760p. Needless to say shareholders are happy, but there were only about half a dozen at the AGM in London.

I’ll cover some of the key questions raised, and the answers, in brief. I asked about the rise in administration costs. This arises from the acquisitions and investment in the management team apparently. I also questioned the high amortisation of acquisition intangibles which apparently relates to customer relationships capitalised but was assured this was not abnormal. This is one of those companies, a bit like Abcam, where the “adjusted” or “underlying” figures differ greatly to the “reported” numbers so one has to spend a lot of time trying to figure out what is happening. It can be easier to just look at the cash flow.

Incidentally the company still has a large amount of debt because that has been raised to finance acquisitions in addition to the use of equity placings. In response to another question it was stated that the policy is to maintain net debt to EBITDA at a ratio of no more than 2.5 to 3 times. But earnings accretion is an important factor.

Geoff spent a few minutes outlining his approach to acquisitions and their integration which was most revealing. He talked a lot of sense. He will never ever buy a failing company. He wants to buy good companies with enthusiastic management. Thereafter he acts as a coach and wants to avoid disrupting the culture. He said a lot of acquisitions fail as people try to change everything wholesale. One shareholder suggestion this was leading to a “rambling empire” but the CEO advised otherwise.

The impact of Brexit was raised, particularly as there is nothing in the Annual Report on the subject. Were there any contingency plans? Geoff replied that if it is messy it will help Victoria as a lot of carpet is made on the continent and a fall in sterling will also help. He suggested they have lower operational gearing than many people think but obviously they might be affected by changing customer confidence. The CEO said that Brexit is on his “opportunity list”, not his “problem list”.

A question arose about the level of short selling in the stock which seems to have driven down the share price of late. Geoff suggested this was a concerted effort by certain hedge funds but he was confident the share price will recover.

Clearly Geoff Wilding is a key person in this company so the question arose about his future ambitions. He expects to do 2, 3 or 4 acquisitions per year and life would be simpler if he didn’t do so many. He tends to live out of a suitcase at present. But he still hopes to be leading the company in 5 year’s time.

In summary this was a useful meeting and I wish I had purchased more shares years ago but was somewhat put off by the debt levels.

Lastly, there was a very interesting article by Mark Bentley on the Beaufort case in the latest ShareSoc newsletter (if you are not a member already, please join as it covers many important topics for private investors). It seems that the possible “shortfall” in assets was only 0.1% of the claimed assets with only three client accounts unreconciled. But administrators PWC and lawyers Linklaters are racking up millions of pounds in fees when the client assets could have been transferred to other brokers in no time at all and at minimal cost. An absolute disgrace in essence. Be sure you encourage the Government, via your M.P., to reform the relevant legislation to stop this kind of gravy train in future.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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The Market, Dunedin and Standard Life Smaller Companies Merger, and Aston Martin IPO

Is it not depressing when you go away for a week’s holiday and your portfolio falls every day in that time? I do monitor any exceptional movements while on vacation but try to avoid trading. It just seemed to be a general downward trend and reviewing the movement over that week my portfolio is down 1.73% while the FTSE All-Share is down 1.72%. So that is what I had already surmised.

Those stocks that seemed to have become overblown did fall and there were some like Scottish Mortgage Trust (SMT) were hit by specific news – in their case the events at Tesla. But the fall in my portfolio last week was less than it went up the previous week. I feel not quite so depressed now I have done the analysis.

Anyway, I am back from holiday now and on my desk is a proposed merger of Dunedin Smaller Companies Investment Trust (DNDL) and Standard Life UK Smaller Companies Investment Trust (SLS). I need to take a decision on this as I hold the latter.

DNDL is smaller than SLS and following the merger of DNDL’s manager, Aberdeen Asset Management, with Standard Life the merged manager now has two trusts with a similar focus. SLS has a superior performance record – 100.7% net asset value total return versus 68.9% for DNDL over the last 5 years. The merged trusts would be managed by Harry Nimmo who has managed SLS for some years.

The directors argue that the merger makes sense because it will result in reduced on-going costs and improved liquidity in the shares, although they don’t quantify either claim. There is no immediate change proposed to the fund management charges on SLS. DNDL will be paying the costs of both parties if the merger goes through.

It no doubt makes sense for the manager to merge these trusts. Not much point in having two trusts in the same stable with a similar focus and they will save on management costs. It also makes some sense for DNDL holders but does it for SLS shareholders?

Enlarging a trust or fund can degrade future returns particularly in small cap funds. This is because buying larger quantities of smaller company shares is more difficult and exiting is also difficult. In other words, the manager may find they cannot be as nimble as before. Alternatively the number of companies in the fund has to grow and we surely know that this is a recipe to reduce returns as there are only so many “good ideas” out there. The more companies in a portfolio, the more likely it is to approximate to a tracker fund.

Therefore, I think I will vote against this merger for that reason.

But what alternatives were there for DNDL shareholders? The company could have changed the manager to avoid the conflict of interest. Or simply wound up if it was too small to be viable. Perhaps a wider international focus when SLS is UK focused would be another alternative.

Luxury car maker Aston Martin is to float on the market. I agree with Neil Collins comments in the FT this weekend – “never buy a share in an initial public offering”. He suggested those who are selling know more about the stock than you do. Car companies, particularly of niche brands, are notoriously tricky investments. Aston Martin has been bust as many as seven times according to one press report. As Mr Collins also said “The private equity vendors are dreaming of a £5 billion valuation for a highly geared business with a decidedly unroadworthy past”.

Car companies exhibit all the worst features of technology businesses. Product reliability issues (which was a bugbear for Aston Martin for many years), very high cost of new model production, Government regulatory interference requiring major changes for safety and emissions, competitors leapfrogging the technology with better products, and sensitivity to economic trends. In a recession few people buy luxury vehicles or they simply postpone purchases – so it’s feast or famine for the manufacturers.

There can be some initial enthusiasm for companies after an IPO that can drive the price higher but the hoopla soon fades. Footasylum (FOOT) was a recent example but McCarthy & Stone (MCS) was another one where investors found that the market proved more challenging than expected.

Resist the temptation to buy IPOs!

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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