Why did you buy that share?

Thursday, 11th August 2016 09:33 - by Eric Chalker

There will be more than one answer to this question, but it becomes particularly pertinent when the investment begins to look like a mistake.  Some shares are bought on momentum and if that continues, fine.  Some are bought for dividend income and if that continues, fine.  But some are bought because of expectations about the business itself and if those expectations are not met, even though the business still seems sound, the fault may lie with its directors. 

When this happens, I have found it helpful to attend the next AGM and observe the directors.  It surprises me that few private investors do this, particularly with smaller companies.  By questioning and, if necessary, challenging the directors face to face – as every shareholder and proxy holder has the right to do – information may be elicited that is not apparent from the annual report, thus enabling a better judgement to be made about holding, selling, or adding shares. 

What is the business strategy?

This is especially true in respect of the directors’ strategy for the business.  We can thank Vince Cable for the Companies Act regulation of 2013 which requires most fully listed companies to state what this is, but some directors are evidently struggling to understand what the words ‘strategy’ and ‘strategic’ mean, which ought to be a cause of worry for any current or would-be investor in those companies.  A strategy as defined by the OED is “a long term plan to achieve a specific purpose” so whatever else a strategic report does it ought to spell out the directors’ strategy.  Companies without a strategy are unlikely to do much for their investors.

AIM companies are not covered by the regulation, but that is no excuse for failing to state what the strategy is.  AIM companies are generally expected to have the greatest growth potential, but that potential needs to be actively exploited, with clearly stated objectives.  Profitable growth of a business may depend less on the business model than on the directors having clear aims for the business and a sound plan to achieve them.  Simply labelling sections of the annual report as the ‘strategic report’, as even many AIM companies now do, does not mean that a strategy is clear or even that one exists.

 Are the directors up to the task?

Part of the problem with AIM companies is that they are all too easy to float, which may happen with directors (recruited by the NOMAD to facilitate the float) whose experience may simply be inadequate.  This may not be apparent from reading the annual report, but it can quickly become evident by exercising one’s rights at an AGM.  Even nominee account users can exercise these rights (by law for ISA users – see my earlier blog on this subject), no nominee has good reason to withhold a proxy appointment and proxies have the same rights at AGMs as shareholders.

Returning to the question that is the title of this article, when a share does not perform as expected you may well feel inclined to dump it without further ado.  But if you bought it because you thought it was a good company and not simply because you expected to make a quick profit, then it may pay you to attend the next AGM and form your own opinion of those into whose hands you have entrusted your money, namely the directors.  Before you do, check the composition of the board (executives versus non-executives), how long the NEDs have been there and what their expertise is: this should all be evident from the latest annual report, but sometimes it isn’t and that itself is a cause for concern.

If the strategy isn’t clear from the annual report, questioning the directors may produce information that reassures you that your investment in the company was sound and you may even want to add to it.  On the other hand, it may become apparent that the directors are presiding over a company that is going nowhere because the board lacks the expertise to set a strategy and make it work, thus giving you a reason to get out.

 Is the company actively selling its wares?

The most important requirement for a company that wishes to grow – and grow profitably – is that it should be market-orientated.  There is a saying attributed to Ralph Waldo Emerson, that “Build a better mousetrap, and the world will beat a path to your door,” but he was a poet, so what did he know?  No matter how wonderful a company’s products or services, if the world is unaware of them it will go elsewhere.  Directors of businesses which seek investors’ money must, if they are not to waste that money, already know this and have the ability to ensure that the executive officers they appoint are driven by the need to market the company’s products and services energetically and profitably.  In my experience, many do not, but this may only become apparent by what they say at the company’s main event, the AGM.

When you have uncertainties about a company’s strategy – what the directors aim to achieve and how they plan to get there – it is well worth while attending the AGM, exploring the facts with questions, ensuring that you get clear answers and satisfying yourself whether the directors, individually and collectively, are up to the task facing them. 

Eric Chalker, UK Shareholders’ Association Policy Co-ordinator & Director, 2012-2016

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.