Monday, 16 June 2014

I invested in a fraudulent company and lost my is what I learned

Things don't always go to plan when you invest in individual stocks.  Some stocks will make you money and others will lose you money.  This post will cover an investment I made two years ago (and which I wrote about on this blog) which went sour and where I lost my whole investment.  I will cover why I made the investment, why it went south and most importantly what I learned from the whole process.

What was the stock and why did I invest in it?

Almost exactly two years ago I invested in a company called Kinghero.  It was a German listed, Chinese manufacturer and fashion retailer aimed at the growing Chinese middle class.  I invested in it for several reasons:
  1. The industry was appealing
    • Getting exposure to the growing Chinese middle market was appealing
    • The company was local and had a decent network of stores and was growing rapidly (i.e. it was not an international retailer chasing growth in a market it didn't understand)
  2. It looked appealing on it's fundamentals
    • The company had little debt and was in a net cash position
    • It was trading on a 2x EBITDA multiple and a 5x PE multiple
    • Further, everything in Europe was depressed at that time as people were worried about the fundamental stability of the Euro zone with a new crisis every week.  This was a stock that was listed in Europe but had no real exposure to Europe - it seemed like a perfect buying opportunity
  3. I did significant due diligence on the stock
    • I did far more due diligence on this stock than I normally do.  I contacted investor relations and the management team of the stock and asked them questions which they happily answered
    • I read broker reports, looked at reviews on their products and a friend who was also investing in the stock went and checked out their stores in China
  4. I gave it time
    • I gave it significant time between finding the stock and actually buying it.  I re-assessed my investment rationale and waited for 2 results (one year) before actually investing in the company to see whether they were delivering on their growth plans

Often in hindsight you can berate yourself for what you should have seen and what you should have researched.  I have no such regrets - I had done my analysis and it stacked up and there was nothing more I could have done in hindsight.

So what went wrong?

It was actually a simple case of fraud by the Managing Director and Chairman of the company.  They were syphoning off the companies assets for their own personal use and had put liens on the company's remaining assets such that the company was effectively trading while insolvent.The German board put the company into a halt and the company's shares stopped trading a few months ago. 

Interestingly, I had thought about fraud at the time I invested in the company.  In fact I had written a post about fraud by Chinese companies and how to avoid getting caught by it.  I actually went through every single one of the steps I outlined in that post...and I still got caught out.

What did I learn...and what would I do differently?

What would I do differently?

The one big sign that I had that something was going wrong was when the company delayed releasing it's 2013 annual report.  One of the large brokers that covered the stock ceased it's coverage at that point because they suspected that something was wrong and the stock price halved.

That was the point at which I should have realised that I had no better information than anyone else.  I was actually just waiting for more information and didn't want to take a ~50% loss on something which may have been perfectly reasonable.

In hindsight I should have sold at this point and been happy with only taking a 50% loss.

What did I learn?

Whenever something goes badly wrong like this I try and make rules for myself to follow in the future.  The last company that I lost a lot of money on was one which I fundamentally didn't understand which went belly up in the GFC.  The rule I developed at that point was that I would only ever invest in companies where I understood:
  1. How they were making their money
  2. Where the risks in their business model were
In addition to this I am now adding the following rules:
  1. I will only invest in countries where there is a strong rule of law (i.e. no more Chinese companies)
  2. If there is the slightest hint of fraud issues I will sell straight away and take my losses
Perhaps I am being too conservative and perhaps I will miss out on some opportunities but this situation taught me that you can do everything right and do all your research and still be taken in by unscrupulous operators.

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  1. Hey 90M,

    It is a shame that we sometimes have to go through these unfortunate experiences but thanks for sharing and hope you'll bounce back bigger and better, sure you will :)

    1. Hi Jef thanks for the comment. I know that some share investments go bad but this is the first time it's ever happened because of fraud. Can only live and learn unfortunately.