Why we got it wrong on Lloyds, Cineworld and Ricardo
Investing successfully is hard. It takes discipline, courage and graft, and even with bags of these qualities, there will still be mistakes and misjudgments.
Some of the most successful investors, such as Warren Buffett, Peter Lynch and Jim Slater, all made bad calls through their long careers but what separates these people from many ordinary investors is the willingness and open-mindedness to learn from their errors.
Here we take a look at three of our own bad calls between 2018 and 2020 in Shares – Lloyds (LLOY), Cineworld (CINE) and Ricardo (RCDO) – and try to draw out what we got wrong and the lessons we have learned.
Our buy call on Lloyds was a very good example of how big picture factors can trip up an investment.
Our thinking in December 2019 was that Boris Johnson’s election victory would result in an end to the political rollercoaster that Britain had been riding and that stability in Government and far more certainty around Brexit would make UK stocks more attractive.
We felt that banks had done a good job at repairing their balance sheets during the decade since the financial crisis, and with an assumed dose of interest rate rises, the backcloth looked hunky dory for UK banks and Lloyds.
‘If they can generate stable profits and pay those profits out as high dividends, I think that will win them some fans among investors,’ said fund manager Alastair Mundy at the time, comments that emboldened our own bullish view.
Sadly, these assumptions were wide of the mark. What we actually saw was a dragged-out pig’s ear Brexit which led to investors continuing to give UK equities a very wide berth and stalling any hopes of a stock market recovery.
Covid also threw a grenade into the mix sending interest rates to all-time lows for what increasingly looks like a prolonged spell.
Compounding the investment mistake, while we ran extensive coverage of these wider issues throughout 2020, we failed to take our own advice on Lloyds, putting us well behind the curve and letting the stock clock up enormous losses – we ultimately cut the stock loose but not until September 2020, far too late. We will be more hands-on in similar situations in the future.
In May 2018 we said to buy the shares at 264.4p, encouraged by a strong slate of new movies and the belief that US expansion would quickly yield benefits.
Management told us that the inherited Regal estate in the US was underinvested, so Cineworld would spruce up the foyers and auditoriums and make them nicer places to visit. This model worked in the past and so we believed it would work again.
We were also told by management that the debt would be quickly paid down. While the investment idea did well for quite a while, we compounded what was ultimately an error by failing to react quickly when red flags started to appear.
We regularly warn readers not to be tempted by heavily indebted businesses, yet we ignored that advice ourselves here. The share price was already sliding when Cineworld revealed plans to make another major acquisition, this time in Canada.
We should have immediately revised our view on the stock because the company’s debts were already big without taking on more borrowings to help fund another multi-billion- dollar acquisition.
Cineworld got too greedy with its growth aspirations. The deal ultimately fell apart as Covid-19 struck and investors found out what happens when a heavily indebted business experiences a sudden downturn in trading – namely a share price collapse.
We were also guilty of allowing our emotions to get in the way of the investment decision. While we enjoy the cinema as a fun night out, we perhaps failed to appreciate that a cinema’s takings are only as strong as the films it is showing, so when a weaker film slate in 2019 emerged, we didn’t pay close enough attention.
Some might consider us unfortunate with Ricardo, with the extent and impact of the pandemic hitting home with investors barely a month after our ‘buy’ call in January 2020.
But we must hold up our hands and accept that miscalculations were made from the off, not least the pace of change at the Sussex-based engineering consultant.
Yes, the company is expanding its remit into new markets, such as defence, rail, energy and environmental sectors, but it remains skewed to the motor industry.
Our assumptions that workloads in emerging business lines would offset declining auto industry exposure simply did not happen and the share price plunged to depths from which it has still to meaningfully recover.
Ultimately, Ricardo was forced to raise fresh funding at a dilutive discount and investors remain very concerned about the performance this financial year to June 2021 after November’s comments that it will be ‘materially more weighted towards the second half of the current financial year than in previous years’, interpreted by many as code for a threat of missing forecasts.