01
Mar
2019

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Acquiring versus outsourcing expertise

Research shows that investing in the stock market over a long-term will produce higher returns than any other asset class. Although investors have to be able to withstand the volatility and some expertise is required. Where should one gain this expertise?

There is more data collected in the asset management industry than just about any other. Returns, volatility of returns, time-frame, risk, compounding, upside/downside capture and the list goes on. A few things are clear. Relative to most asset classes – farmland, commercial property, gold, government bonds and bank term deposits – shares have provided the best (ungeared) investment returns of any asset class since the Second World War. However, this has been accompanied by higher volatility – in simple terms the stock market goes up and down more than any other asset class.

A second point to understand is the power of compounding. Small differences in annual rates of return on the various asset classes have a large impact on long term results.

While investing in low return asset classes, such as bank term deposits, can reduce anxiety through a reduction in volatility and shorter-term (paper) losses, it can have a higher long-term cost in terms of lower capital accumulation.

The stock market is a volatile but rewarding place to invest and is therefore most suitable for investors who have a long-term time horizon and can ride out the volatility inherent in the share market. And this assumes some expertise is acquired in avoiding the dangers while also making the most of the opportunities which abound in the market.

This introduction brings me on to the subject of expertise, particularly when we see a huge number of people seeking financial advice and stock tips from their family and friends. Is this always the right path in meeting your objective of accumulating wealth?

Let me illustrate the point about stock tips through an unnamed small Company which listed on the ASX three years ago. The CEO is a good friend of mine, and many of our mates became shareholders in the Company, excited by its positioning, the vision and the prospects. Furthermore, the Non-Executives who joined the Board during the IPO were highly impressive individuals, all very successful in their own right.

A good look at the Prospectus revealed a loss-making business with minimal revenue, $18 million of annual expenses, around $25 million of retained losses and no financial forecasts for 2016. The Company raised $62 million in the IPO process with the objective of expanding each of sales and marketing; research and development; implementation capabilities; new initiatives; and working capital requirements.

In its first six months as a publicly listed company, a number of exciting contract announcements were made, the share price doubled, and the bulls were celebrating.

Fast forward to today. Retained losses have jumped to $120 million, the share price is down over 90 per cent from its peak, and the recent “strategic review” has seen the business model significantly streamlined. For example, the cost base in 2019 is expected to be 30 per cent lower than it was in 2017. And another capital raising (on top of a $30 million raising in late-2017) appears likely.

But this is where the exciting stuff starts, particularly when we consider the depressed share price. The Company’s revenue line is growing strongly, and the relative contribution from the recurring revenue line is becoming increasingly significant. While I expect 2019 will be another loss-making year, the rising revenue/ falling expense trends are starting to pique my interest.

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