Don’t count your chickens – even when they have hatched #FTC #IQE

Don’t count your chickens – even when they have hatched #FTC #IQE

Everyone loves the idea of that one stellar multi-bagger that makes their fortune don’t they?

Even though I think there are easier and safer ways to make money from the market, I cannot resist taking some interest in the subject and perhaps the occasional flutter.

There is no shortage of stories of single stocks that put individual investors on the path to riches by investing before they were very profitable or perhaps even before they made any revenue. I have no reason to doubt a lot of these stories, although I do wonder if there is not an element of history being written by the victors.

The majority of “story stocks”, however, fail for one reason or another, including :

  • The market opportunity never really existed or was overstated.
  • A competitor or alternative technology gets there first.
  • They run out of money before they can commercialise. (Which is not always terminal, but often means the early investors get ridiculously diluted)

A pattern I see repeated often amongst these ‘story stocks’ is that of an exciting announcement being made that supports ‘the story’  (perhaps a new partnership, entry into a new market, even a new sales manager) this is followed by a sharp upward movement in the share price. Fear of missing out on the story coming to fruition drives the price on further, for a few days. However, unless there was any substance in the news in terms of actual income and profit, interest wanes and the share-price, more often than not, goes into reverse. (Many of these stories are nothing but ‘puff’.)

As an investment approach, it surely makes more sense to wait until there is material business coming in that will drive value in the company?

Certainly you’ll miss out on buying the shares for ‘pennies’ and instead have to settle for paying 10s of pennies, but if ultimately the share-price will be measured in pounds/ it is a small price to pay for a much greater certainty of outcome.

However, even this more cautious approach is not totally reliable.

Two examples of ‘story stocks’ apparently breaking through have grabbed me in the last few months.

Case One : Filtronic (LON:FTC)

The opportunity.

Filtronic is a small producer of telecoms gizmos. To cut the investment case short,  in the summer of last year Filtronic shares were trading at around 10p valuing the business at c. £20m. Filtronic had a validated “massive MIMO” (mMIMO) antenna with Nokia and had initial business with a major US mobile operator (one pilot contract fulfilled and a second issued).  mMIMO is an important technology in 5G mobile networks and the market forecasts for the next 10 years are huge. This single contract rolled out across the network would have conservatively valued Filtronic North of £100m and even a modest market share in the wider market, substantially more.

Helped by a tip from Small Company Share Watch, the market began to cotton on to the fact that the story was coming true and the share-price rose in short order to c. 30p (still a relatively modest market cap of £60m).

The bad news.

All was going swimmingly and then bang, the company issued a statement (12-Dec-18) : “Our predominant OEM customer, .. , has now significantly lowered its forecast demand below that which it had previously provided, having itself been advised that its lead client is now looking to deploy different frequencies to those it had originally indicated.”

Ouch! – Filtronic took the step of completely writing off their development costs on this project and the jam that one could almost smell, was gone. The share-price collapsed to a little over 5p.

So even successful initial trials and follow up orders from a customer of sufficient scale to transform the business was not enough to make this investment safe.

Case 2 : IQE (LON:IQE)

The Opportunity.

IQE is a manufacturer of compound semi-conductor wafers, used in turn to manufacture a range of chips and devices for multiple applications.

Again, the future market scale here looks massive and the progress was much further advanced than in the case above.  One of the early transformative applications was VCSELs, used in 3D sensing in the iPhone X. In 2017, IQE supplied these wafers to support the iPhone X roll out, bringing in significant extra business. This was just the first phase: Apple would make use of this technology in a broader range of devices and other applications and customers were just around the corner.

The story for 2018 was still predominantly about Apple. In line with IQE’s product rollout cycle, most of the business would be delivered in the last few months of the year.

The bad news.

Even ‘signed orders’ (some of which I am sure IQE had already manufactured) were not sufficient to make this ‘story’ secure either!

In November, IQE received notice via the supply chain (in fact bizzarely by a public announcement from one of its direct customers) that Apple was cancelling the vast majority of the order as it had a glut of stock. (I paraphrase and should also point out due to onerous non-disclosure agreements, Apple are never actually mentioned).

The company’s profits for the year were pretty much wiped out by this single event, and the share price collapsed 40% from 94p to 56p. A second ouch!

Learning the lessons.

Eagle-eyed readers will no doubt spot that in both instances the opportunity at the time was heavily reliant on a single customer in each case. Clearly this is a risk factor that one needs to be aware of, but if you want to invest in companies breaking new opportunities it is not always an avoidable risk.

The bigger learning point for me is to be much more demanding in testing whether business opportunities are actually taking off profitably (this is something I will no doubt come back to in future).

For now, I do not actually regard either company as a ‘busted flush’; they are merely return to the pile marked ‘of interest but as yet unproven’ (with now a higher threshold for that last word).



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    Good thoughts Tony. Thank you for the article. 

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