Lloyds Shareholders Lose Case

After many months of deliberation, a judge in the High Court has rejected the claims by former Lloyds TSB shareholders over the takeover of HBOS and recapitalisation of the company by the Government. That resulted in major capital losses to Lloyds Banking Group (LLOY) shareholders and suspension of the dividends which many private shareholders relied on for income.

For those not familiar with the case, this stems from the events in 2008/9 when all banks came under severe financial pressure. HBOS was clearly in major difficulties due to imprudent commercial lending although how bad its position really was only became public much later. But there seemed to be only two credible options as nobody was willing to refinance it – nationalisation by the Government or a takeover by another large bank. Lloyds TSB agreed to do the latter with Government financial support. A prospectus was issued and voted upon. The shareholders supported it based on what they were told, but many institutional shareholders held both Lloyds TSB and HBOS so had a vested interest in the deal going through.

Note that this writer had an interest in the case because I held some shares in Lloyds TSB but I was not a claimant in the litigation because I sold most of my shares as soon as I knew the deal was going through this minimising my losses. However I did provide a witness statement to the court via solicitors Harcus Sinclair who represented the shareholders. I did write some articles at the time complaining about the deal and its likely effect on shareholders and met with Sir Victor Blank, then Chairman of Lloyds TSB who defended the actions of the company.

The claim which was against the company and the directors was based on two specific issues: 1) that the directors had recommended the deal when it was not in the interests of Lloyds TSB shareholders which is all they should have considered; and 2) the prospectus did not disclose the financial support in loans received by HBOS from Lloyds, the Bank of England and the US Federal Reserve. Prospectuses should disclose all relevant information under the relevant legislation.

It seems the court judgement was that the directors were not negligent in recommending the acquisition of HBOS and that the failure to disclose the HBOS funding would not have affected the outcome of the vote on the deal. But the judge acknowledged that the failure to disclose the funding was wrong.

Last week I gave a talk on Business Perspective Investing in which I argued that company accounts are not be relied upon. This latest judgement implies that a prospectus is now not be relied upon either. It can be grossly misleading but nobody will be held to account for that.

This is a most disgraceful outcome and I hope that an appeal is made.

The costs of pursuing this legal case are also a disgrace. Lloyds solicitors expected to run up costs of more than £25 million and there were probably similar costs incurred by the other party. There were weeks in court and it was a pretty impressive scene when I attended with at least 6 barristers in wigs and gowns plus about another 10 supporting legal staff. In essence what were in essence quite simple issues became a beanfeast for lawyers and demonstrates much of what is wrong with the English legal system. It’s now ten years since the events on which the litigation was based took place and many claimants have since died. And at the end for all that time and expense, justice was not well served.

If shareholders in such a major and simple case supported by litigation funding cannot obtain justice, what chance do they have in the case of misdeeds by directors in smaller companies? None at all in summary.

Go here if you wish to read the full judgement of the case: https://www.judiciary.uk/judgments/sharp-others-v-blank-others-hbos-judgment/

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

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BT Nationalisation and Promises, Promises

We are clearly in a run up to a General Election when politicians promise all kinds of “free” gifts to the electorate. The latest promise, even before the manifestos have been published, is the Labour Party’s commitment to give everyone in the UK free broadband. This would be achieved by simply nationalising BT Group (BT.A) apparently.

I just had a quick look at the cost of this commitment. BT actually receives over £15 billion annually according to the last accounts from Consumers and from Openreach. There is some profit margin on that of less than 20% which might be discounted, but there are many households who do not yet have a fibre connection so that would be an additional cost to be covered by the Government.

In addition there would probably be some cost of nationalising BT Group and paying compensation to shareholders. The current market cap of the company is about £19 billion. They might get away with paying £10 billion up front but the annual cost of at least £12 billion to maintain the network would be an enormous burden on the state. They might be able to raise that by taxing multinationals or others but it still makes no sense.

I am not a BT shareholder currently although I am one of their customers. I also remember how dreadful the service from BT was before it was nationalised. It may not be perfect now in comparison with some of their competitors but nationalised industries such as telecoms, the railways, the motor industry, the coal industry, shipbuilding, the gas/electric/water utilities and about 40 others were all abject failures. They typically lost money and provided diabolical service.  The young who are voting socialist may not remember but Jeremy Corbyn should do so.

The fact that the share price of BT only dropped by 1% today (at the time of writing) just shows you how much credibility investors attach to this promise. It also surely shows how desperate the Labour Party is to win some more votes as they are now trailing well behind in the opinion polls.

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

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Mello Event, ProVen and ShareSoc Seminars and Lots More News

It’s been a busy last two days for me with several events attended. The first was on Tuesday when I attended the Mello London event in Chiswick. It was clearly a popular event with attendance up on the previous year. I spoke on Business Perspective Investing and my talk was well attended with an interesting discussion on Burford Capital which I used as an example of a company that fails a lot of my check list rules and hence I have never invested in it. But clearly there are still some fans and defenders of its accounting treatment. It’s always good to get some debate at such presentations.

On Wednesday morning I attended a ProVen VCT shareholder event which turned out to be more interesting than I expected. ProVen manages two VCTs (PVN and PGOO), both of which I hold. It was reported that a lot of investment is going into Adtech, Edtech, Fintech, Cybersecurity and Sustainability driven by large private equity funding. Public markets are declining in terms of the number of listed companies. The ProVen VCTs have achieved returns over 5 years similar to other generalist VCTs but returns have been falling of late. This was attributed to the high investment costs (i.e. deal valuations have been rising for early stage companies) in comparison with a few years back. Basically it was suggested that there is too much VC funding available. Some companies seem to be raising funds just to get them to the next funding round rather than to reach profitability. ProVen prefers to invest in companies focused on the latter. Even from my limited experience in looking at some business angel investment propositions recently, the valuations being suggested for very early stage businesses seem way too high.

This does not bode well for future returns in VCTs of course. In addition the problem is compounded by the new VCT rules which are much tougher such as the fact that they need to be 80% invested and only companies that are less than 7 years old qualify – although there are some exceptions for follow-on investment. Asset backed investments and MBOs are no longer permitted. The changes will mean that VCTs are investing in more risky, small and early stage businesses – often technology focused ones. I suspect this will lean to larger portfolios of many smaller holdings, with more follow-on funding of the successful ones. I am getting wary of putting more money into VCTs until we see how all this works out despite the generous tax reliefs but ProVen might be more experienced than others in the new scenario.

There were very interesting presentations from three of their investee companies – Fnatic (esports business), Picasso Labs (video/image campaign analysis) and Festicket (festival ticketing and business support). All very interesting businesses with CEOs who presented well, but as usual rather short of financial information.

There was also a session on the VCT tax rules for investors which are always worth getting a refresher on as they are so complex. One point that was mentioned which may catch some unawares is that normally when you die all capital gains or losses on VCTs are ignored as they are capital gains tax exempt, and any past income tax reliefs are retained (i.e. the five-year rule for retention does not apply). If you pass the VCT holdings onto your spouse they can continue to receive the dividends tax free but only up to £200,000 worth of VCT holdings transferred as they are considered to be new investments in the tax year of receipt. I hope that I have explained that correctly, but VCTs are certainly an area where expert tax advice is quite essential if you have substantial holdings in them.

One of the speakers at this event criticised Woodford for the naming of the Woodford Equity Income Fund in the same way I have done. It was a very unusual profile of holdings for an equity income fund. Stockopedia have recently published a good analysis of the past holdings in the fund. The latest news from the fund liquidator is that investors in the fund are likely to lose 32% of the remaining value, and it could be as high as 42% in the worst scenario. Investors should call for an inquiry into how this debacle was allowed to happen with recommendations to ensure it does not happen again to unsuspecting and unsophisticated investors.

Later on Wednesday I attended a ShareSoc company presentation seminar with four companies presenting which I will cover very briefly:

Caledonia Mining (CMCL) – profitable gold mining operations in Zimbabwe with expansion plans. Gold mining is always a risky business in my experience and political risks particularly re foreign exchange controls in Zimbabwe make an investment only for the brave in my view. Incidentally big mining company BHP (BHP) announced on Tuesday the appointment of a new CEO, Mike Henry. His pay package is disclosed in detail – it’s a base salary of US$1.7 million, a cash and deferred share bonus (CDP) of up to 120% of base and an LTIP of up to 200% of base, i.e. an overall maximum which I calculate to be over $7 million plus pension. It’s this kind of package that horrifies the low paid and causes many to vote for socialist political parties. I find it quite unjustifiable also, but as I now hold shares in BHP I will be able to give the company my views directly on such over-generous bonus schemes.

Ilika (IKA) – a company now focused on developing solid state batteries. Such batteries have better characteristics than the commonly used Lithium-Ion batteries in many products. Ilika are now developing larger capacity batteries but it may be 2025 before they are price competitive. I have seen this company present before. Interesting technology but whether and when they can get to volumes sufficient to generate profits is anybody’s guess.

Fusion Antibodies (FAB) – a developer of antibodies for large pharma companies and diagnostic applications. This is a rapidly growing sector of the biotechnology industry and for medical applications supplying many new diagnostic and treatment options. I already hold Abcam (ABC) and Bioventix (BVXP) and even got treated recently with a monoclonal antibody (Prolia from Amgen) for osteopenia. One injection that lasts for six months which apparently adjusts a critical protein – or in longer terms “an antibody directed against the receptor activator of the nuclear factor–kappa B ligand (RANKL), which is a key mediator of the resorptive phase of bone remodeling. It decreases bone resorption by inhibiting osteoclast activity”. I am sure readers will understand that! Yes a lot of the science in this area does go over my head.

As regards Fusion Antibodies I did not like their historic focus on project related income and I am not clear what their “USP” is.

As I said in my talk on Tuesday, Abcam has been one of my more successful investments returning a compound total return per annum of 31% Per Annum since 2006. It’s those high consistent returns over many years that generates the high total returns and makes them the ten-baggers, and more. But you did not need to understand the science of antibodies to see why it would be a good investment. But I would need a lot longer than the 30 minutes allowed for my presentation on Tuesday to explain the reasons for my original investment in Abcam and other successful companies. I think I could talk for a whole day on Business Perspective Investing.

Abcam actually held their AGM yesterday so I missed it. But an RNS announcement suggests that although all resolutions were passed, there were significant votes against the re-election of Chairman Peter Allen. Exactly how many I have been unable to find out as their investor relations phone number is not being answered so I have sent them an email. The company suggests the vote was because of concerns about Allen’s other board time commitments but they don’t plan to do anything about it. I also voted against him though for not knowing his responsibility to answer questions from shareholders (see previous blog reports).

The last company presenting at the ShareSoc event was Supermarket Income REIT (SUPR). This is a property investment trust that invests in long leases (average 18 years) and generates a dividend yield of 5% with some capital growth. Typically the leases have RPI linked rent reviews which is fine so long as the Government does not redefine what RPI means. They convinced me that the supermarket sector is not quite such bad news as most retail property businesses as there is still some growth in the sector. Although internet ordering and home delivery is becoming more popular, they are mainly being serviced from existing local sites and nobody is making money from such deliveries (£15 cost). The Ocado business model of using a few large automated sites was suggested to be not viable except in big cities. SUPR may merit a bit more research (I don’t currently hold it).

Other news in the last couple of days of interest was:

It was announced that a Chinese firm was buying British Steel which the Government has been propping up since it went into administration. There is a good editorial in the Financial Times today headlined under “the UK needs to decide if British Steel is strategic”. This news may enable the Government to save the embarrassment of killing off the business with the loss of 4,000 direct jobs and many others indirectly. But we have yet to see what “sweeteners” have been offered to the buyer and there may be “state-aid” issues to be faced. This business has been consistently unprofitable and this comment from the BBC was amusing: “Some industry watchers are suggesting that Scunthorpe, and British Steel’s plant in Hayange in France would allow Jingye to import raw steel from China, finish it into higher value products and stick a “Made in UK” or “Made in France” badge on it”. Is this business really strategic? It is suggested that the ability to make railway track for Network Rail is important but is that not a low-tech rather than high-tech product? I am never happy to see strategically challenged business bailed out when other countries are both better placed to provide the products cheaper and are willing to subsidise the companies doing so.

Another example of the too prevalent problem of defective accounts was reported in the FT today – this time in Halfords (HFD) which I will add to an ever longer list of accounts one cannot trust. The FT reported that the company “has adjusted its accounts to remove £11.7 million of inventory costs from its balance sheet” after a review of its half-year figures by new auditor BDO. KPMG were the previous auditor and it is suggested there has been a “misapplication” of accounting rules where operational costs such as warehousing were treated as inventory. In essence another quite basic mistake not picked up by auditors!

That pro-Brexit supporter Tim Martin, CEO of JD Wetherspoon (JDW) has been pontificating on the iniquities of the UK Corporate Governance Code (or “guaranteed eventual destruction” as he renames it) in the company’s latest Trading Statement as the AGM is coming up soon. For example he says “There can be little doubt that the current system has directly led to the failure or chronic underperformance of many businesses, including banks, supermarkets, and pubs” and “It has also led to the creation of long and almost unreadable annual reports, full of jargon, clichés and platitudes – which confuse more than they enlighten”. I agree with him on the latter point but not about the limit on the length of service of non-executive directors which he opposes. I have seen too many non-execs who have “gone native”, fail to challenge the executives and should have been pensioned off earlier (not that non-execs get paid pensions normally of course. But Tim’s diatribe is well worth reading as he does make some good points – see here: https://tinyurl.com/yz3mso9d .

He has also come under attack for allowing pro-Brexit material to be printed on beer mats in his pubs when the shareholders have not authorised political donations. But that seems to me a very minor issue when so many FTSE CEOs were publicly criticising Brexit, i.e. interfering in politics and using groundless scare stories such as supermarkets running out of fresh produce. I do not hold JDW but it should make for an interesting AGM. A report from anyone who attends it would be welcomed.

Another company I mentioned in my talk on Tuesday was Accesso (ACSO). The business was put up for sale, but offers seemed to be insufficient to get board and shareholder support. The latest news issued by the company says there are “refreshed indications of interest” so discussions are continuing. I still hold a few shares but I think I’ll just wait and see what the outcome is. Trading on news is a good idea in general but trading on the vagaries of guesses, rumours or speculative share price movements, and as to what might happen, is not wise in my view.

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

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Pound Jumps Up on Brexit Party News and Portfolio Impact

The pound has risen by about 1% against the US Dollar and Euro today with suggestions that it is the news from Nigel Farage’s Brexit Party that prompted it. He won’t be putting up candidates in seats where the Conservatives won the vote last time when he was previously threatening to have candidates stand in all constituencies. This makes some sense because even if they have good candidates willing to stand, building a local campaigning organisation from scratch to get the vote out is not easy. It strengthens the probability of a Conservative win although there is still some risk because in marginal seats which the Conservatives hoped to win but lost last time there could still be a split vote.

The result has been quite significant on my portfolio with companies with large overseas revenues and profits falling while UK dominated businesses rose. That was particularly so with Greggs (GRG) who are up 16% on the day after a trading statement that indicated overall sales were up 12.4% for the last 6 weeks and year end figures should be even better than expected.  Sales growth continues to be driven by increased customer visits apparently but as many of their outlets are now not on the High Street I suggest that should not be seen as a revival for other retail businesses. But Greggs certainly seem to have a winning formula of late as they consistently report positive news.

I tend not to react to short term changes in exchange rates because the impact can be more complex that first appears. I will not therefore be taking any steps as a result. In any case my overall portfolio is up 0.5% on the day so this might just reflect more confidence that the political log-jam will finally be resolved in a few weeks’ time. Investor confidence has a big influence on markets of course.

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

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A Question Answered on Winners and Losers

When I tweeted a mention of my forthcoming presentation on Business Perspective Investing, Andrew responded that he would be interested in a list of my winners and losers over the years and lessons learnt. So here’s some of them.

Health warning: this is not a recommendation to buy, sell or otherwise speculate in these companies. Some of the companies have been sold, or been delisted due to takeovers or other reasons. The notes are only a very trivial analysis of the reasons I purchased them. I will not be advising of future changes to my shareholdings and I have not included relatively new purchases for the same reason.

I give the company name, the year first purchased and the compound annual return (including dividends) reported by Sharescope up to the current date, or when sold. Note that I rarely purchase large holdings at once, but tend to buy more over time if the performance is good. If the performance is poor they are sold so the losses are minimised.

Most of the winning companies show consistent growth in revenue, operate in growing markets, have a high return on capital, positive cash flow, some intellectual property (IP) and competent management. Many of the companies have exploited the internet to provider a quicker or lower cost service.

Some of the Winners:

4Imprint (2016: 31.0%). A simple business distributing promotional merchandise, sold over the internet.

AB Dynamics (2015: 74.6%). Automotive technology gaining from the need for improved testing requirements and automated vehicle needs.

Abcam (2006: 31.1%). Distributor and producer of antibodies and proteins used in medical research, sold over the internet.

Accesso (2012: 32.0%). Visitor attraction software and services. Consolidator in a diverse sector.

Bioventix (2014: 39.3%). Producer of antibodies for medical diagnostics.

Boohoo (2014: 108.8%). On-line clothes retailer. Benefiting from changing shopping habits.

Delcam (2003: 26.3%). Computer aided design software for manufacturing.

Diploma (2015: 28.6%). Specialised technical products in life sciences, seals and controls.

DotDigital (2011: 33.2%). Email and other business marketing services.

Fevertree (2017: 89.4%). Producer/distributor of drinks and mixers. Great marketing and strong branding with outsourced manufacturing.

GB Group (2003: 31.6%). Identity checking internet services, benefiting from the need for quicker ID checks.

Ideagen (2012: 36.0%). Software for GRC applications. Driven by both organic growth and acquisitions, higher regulatory demands and strong sales management.

Judges Scientific (2010: 25.6%). Producer of scientific instruments. Organic and acquisition growth and emphasis on buying small companies that are cheap that can deliver a high return on capital.

Moneysupermarket (2011: 19.6%). Internet price comparison services.

Rightmove (2012: 21.2%). On-line estate agency portal. Benefiting from network effects and being the market leader.

Safestore (2018: 29.5%). Self-storage property company. Growing need to store personal and business items.

Segro (2016: 26.1%). Property company specialising in warehousing. A growing sector from internet distribution need.

Tracsis (2013: 17.1%). Software for rail operators.

Victoria (2012: 74.8%). Floor covering manufacturer led by charismatic manager.

Some of the Losers:

Blancco Technology (2016: -34.1%). IT product erasure and diagnostics. Dubious and inaccurate accounts.

Patisserie Holdings (2017: -100%). Totally fraudulent accounts led by Executive Chairman who failed to watch the detail I suggest.

As you can see, the industries in which the successful companies operate are quite varied but there is a strong focus on “newer technology” companies providing internet services or software. Although technology has been a hot sector in recent years, that has been so for most of my investing life and I expect it to continue. Note how my prejudices against certain sectors are reflected in the above list. Although I have invested in a few mining and oil producers over the years, they were generally not successful investments. Likewise financial businesses with minor exceptions.

The per annum returns may not appear spectacular but it is the high returns over many years that makes them an outstanding investment (or “ten baggers” as some are – for example Abcam has compounded at over 30% per annum for thirteen years). It may be unable to continue to do so but the company still has ambitious growth plans.

The high performing companies listed tend to be smaller ones but my portfolio does hold some larger FTSE-100 and FTSE-250 companies. The more successful ones of those don’t achieve such high returns as the companies listed above but typically more in the 10% to 20% per annum range. I also hold a number of investment trusts and funds which have similar returns. But the lower returns on those are compensated for by the lower risks associated with them.

Some of the companies have changing performance over time. For example Accesso was a strong performer until recently. I tend to top-slice companies when they become over-rated by the market or there are significant changes in the business, and try to buy when they are still cheap.

Andrew also asked “if people didn’t put as much time into it as you, do you think they can make it work?” Effort in any game is rewarded. Likewise the more experience you have the better you get. That usually means some time commitment is required. But whether you spend a lot of time or little, the key is to use the time effectively and not try to research everything in absolute detail. There is more information available than you can hope to handle in the modern world. Experience tells you what is important of course and what can be ignored. My book “Business Perspective Investing” just suggests what is important to look at, and what is not.

Note that I will be giving some overall portfolio performance information at my presentation next Tuesday (the 12th November at the Mello London event).

Incidentally ShareSoc/UKSA have published their joint submission to the consultation on “Intermediated Investments” from the Law Commission. It is very similar in content to my own but even more detailed on the problems of nominee accounts and how they should be fixed. It’s well worth reading. See here:

https://www.sharesoc.org/sharesoc-news/sharesoc-uksa-response-law-commission-review-of-intermediated-securities-call-for-evidence/

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

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Mothercare Downfall – A Breakdown in Trust?

Mothercare (MTC) have announced that its two UK operating subsidiaries are going into administration. The company services over 1,000 stores worldwide, and apart from the UK they report a profit. But losses in the UK more than offset profits in the rest of the world if you read the last annual report. The share price has fallen 30% today at the time of writing.

There were clear warning signs here. For example this is what it says in the Annual Report published in May under “What went wrong” after mentioning “an acceleration of events”: “the difficult situation was further fuelled by a fracture in the relationship between the non-executive and operating executives, a break-down in trust with key shareholders and the appointment of an array of increasingly expensive professional advisers”. That’s a very unusual thing to actually say to shareholders! It hardly inspires confidence does it.

It is also noticeable that even if overseas sales were profitable, there were declines in like-for-like sales both there and in the UK. And needless to point out perhaps that this is one company that is most likely to have been affected by changing shopping habits. Do mothers with children or young babies really want to be dragging them around the High Street? No they will order what they need on-line. A quick look at the Mothercare web site says they do offer free delivery on orders over £50 but why bother when other on-line sites will do it for much less.

Mothercare has always had a great “brand” but has never seemed able to turn it into a profitable business – at least in the UK.

Note that only the UK operations have gone into administration but it’s difficult to see how the parent holding company is going to avoid major problems as a result as debts are probably secured against all the assets and there may be substantial intercompany debts.  And what about the pension scheme and the sale and leaseback of the head office which means future costs? I have not researched the company enough to advise further but almost everything I read in the Annual Report puts me off the business.

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

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Exchange Market Size in Stockopedia and BHP plus RIO

I noticed that the share prices of BHP Group (BHP) and Rio Tinto (RIO) jumped this morning – at least for these behemoths of the FTSE-100 they moved substantially at 2.8% and 3.4% respectively. I only noticed because I recently purchased some of the shares in each company.

These are of course very large mining companies so they are dependent on the price of metals and metal ore, particularly iron ore. The last time I looked at these companies was two or three years ago when they were laden down with debt and had poor returns on capital. But they have certainly had a change of heart since then and seem to be more focused on generating real profits and cash flow rather than building ever bigger holes in the ground. Debt has been cut substantially in both companies.

With the profits mainly coming from overseas, they are a good hedge against any form of Brexit, and yields are high for those who like dividends. I am not a great fan of commodity-based businesses where predicting future prices of the products is not easy and they typically go through boom and bust cycles as such companies all invest in new production capacity at the same time as prices go up. Soon after when all the new capacity comes on stream there is a bust of course. But I made a small exception in this case.

But why the share price jump this morning? Are investors moving from growth to value as other commentators have suggested? Have value shares such as BHP and RIO suddenly started to look attractive, as they did to me? Or has Nigel Farage’s impossible demands for a deal with the Conservatives to ensure Brexit over the weekend suddenly encouraged investors to look for Brexit hedges?

Stockopedia have released an updated version of their “New” software. It now includes the Exchange Market Size (EMS) which is a useful parameter to look at when trading in company shares, particularly smaller ones. Note that Exchange Market Size was previously called Normal Market Size.  It is the maximum size in terms of share trade volume at which a market maker is obligated to adhere to their quoted share prices. It is a very good indicator of the liquidity in the shares and how easy they will be to trade. When trading electronically on most retail platforms, this is a useful number to know as it will affect whether you can trade automatically, have to set a limit order or get a dealer to trade for you. In addition, any trade bigger than the EMS might be done at prices higher or lower than you expect.

This number can be very small for some AIM stocks. For example on Bango (BGO) which I hold it is currently only 3,000 shares (less than £4,000 in value) when the EMS for BHP and RIO is more equivalent to £20,000 in value.

The new Stockopedia software version has other improvements although I still seem to be having problems with the Stock Alerts feature that I use every day. Perhaps there are still some issues that have yet to be fixed but you can still revert to the old version.

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

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