Four wealth destroyers and three that could make you rich
Many investors buy into big monolithic companies such as BP, RBS or British Airways in the belief that they are a safe bet and will carry on producing income as they have in the past. But big isn't always best. Tom Bulford explains why.
Some of the best known companies on the stock market are destroying wealth.
In this issue, I'll explain why that is. I'll also show you where I think you should be putting your money right now to avoid the same fate. I'll start with a personal experience...
I played golf at the weekend. It's my favourite way to unwind from the working week and a great place to hear about people's investment experiences.
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My partner for Saturday's round was not a happy man. Three years ago, he told me, he retired, got a nice lump sum and decided to invest in some safe shares.
'Let me guess,' I said. 'BP was one of them?'
'Yes'
'... and Prudential was another?'
'Right'
'... and you bought RBS?'
'I am afraid so'.
'British Airways?'
'No, not that one!'
So it could have been worse. He only had three out of these four duds. I asked him what he was going to do about his ugly trio.
'Oh, I won't sell them!' he said. 'I'll hold on...'
This, sadly, is all too typical of the average investor. He buys into a few companies that he thinks must be safe because: they have been around for a long time; and/or they are too big to fail; and/or he thinks he knows something about them.
And then, if they turn sour, he assumes that they must recover if he only shows a bit of loyalty.
Beware this common misconception about big companies
Unfortunately though, there is no stock market rule that says 'what goes down must go up.' And there are no loyalty bonuses for just hanging on to shares. In fact when a big company messes up, shareholders should ask why. Because the pressures that cause one accident can all too easily cause another.
Other small-cap news
- Shares in AIM-listed Northern Bear (ticker: NTBR) rise 20% in early trading.
- The company provides specialist building services in Northern England. Its strategy is to acquire mature and cash generative building services businesses.
- The company says that "the new financial year has started well, with strong order books and a healthy pipeline, both far exceeding the outlook at the corresponding time last year."
- Annual results will be announced on 7 July
It is easy to dismiss the assorted problems of BP, the Prudential, RBS and British Airways as unconnected, just random problems that happen to have come along at the same time. But that is not my view.
Each of these big companies is under pressure to grow. They all have, or have had, new bosses who needed to prove their mettle. They all have a group of institutional shareholders who demand growth whatever the realities of the situation or the possible consequences.
Take BP, for example. In comes new boss Tony Hayward. To earn his spurs he introduces a cost-cutting drive. City shareholders love this. Cost cutting is a 'quick win.' It's much easier to boost profits by cutting costs than by embarking upon new investment projects.
BP's profits duly rise. Fund managers salivate. Journalists write gushing copy about Hayward. Now, though, it seems that BP has been playing fast and loose. There's just one thing preventing it from being wiped out. That's the fact that it's still a big fat goose capable of dropping golden eggs into the hands of plaintiffs and lawyers for years to come.
Now take the Prudential. Here again we have a company that is so big that it inevitably struggles to break into a trot. So how can new boss Tidjane Thiam make a name for himself? His plan was to spend $35bn on the Asian business of AIG. Shareholders, though, did not like the deal and it was scrapped.
But here's the real scandal. Despite the fact that nothing was achieved, the Prudential has still burnt £450m of its shareholders' money, mainly on fees to its financial and legal advisers.
For big companies, this is all too typical. Financial advisers want big fees. They know that the way to get them is to pitch new business ideas to major companies. No doubt they would have raked off even more had the bid gone though. But £450m is still a pretty tidy amount of shareholder money to have siphoned off.
A wake-up call for anyone looking for serious investment success
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Like BP and the Prudential, RBS and British Airways are big players locked in fiercely competitive industries. They have no 'pricing power'. In other words they have to sell their products and services for no more than the market will allow. Just to stay in the game they need to constantly battle against costs, and even their best efforts can only achieve minimal revenue growth.
As we saw with the banking industry, they are desperately vulnerable to the herd instinct, recklessly writing new business just because everybody else is doing the same. And such is the criticism that they attract for simply chugging along slowly, they are inevitably drawn into bold strategic initiatives that all too often end in disaster.
And yet most people consider these giants to be sound, blue chip, stick-them-away-in-the-bottom-drawer investments. It's time for these people to wake up.
You and I both know something these investors don't. We know that you should diversify your portfolios by investing in small companies that have room to grow. As well as companies that are already established, you should back companies and industries that are only just starting to emerge.
Successful investing comes not from blind loyalty. It comes from ditching the failures and sticking with the winners. And if you're prepared to take on higher risk, then there is no better place to look for huge investment rewards than the small company sector.
Three shares that could make you between two and six times your money
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An ingenious solution to one of the world's most pressing environmental problems.
A remarkable turnaround story in a simple 'people business'
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Please do let me know what you think and look out for Friday's new issue too!
This article was first published in Tom Bulford's twice-weekly small-cap investment email The Penny Sleuth .
Join more than 165,000 subscribers and keep yourself informed with the latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International, he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund.