Share Sleuth: Why ‘doing nothing’ is sometimes the best course of action

Market research agency System1 released a profit warning in August. While profit

One company in the Share Sleuth portfolio has performed unexpectedly well in recent months and one surprisingly badly. How we respond to shock news says a lot about us as investors.

Market research agency System1 released a profit warning in August. While profit warnings can be temporary hiccups that tell us little about the long-term prospects for a business, System1’s may have revealed more.

One reason why profit will be lower when the company announces its results for the half-year is that some customers are no longer using its concept-testing product. Companies run new concepts past consumers to work out whether they will make good products. System1 uses predictive markets, a method plucked from behavioural science.

System1 pioneered behavioural techniques, so having done many tests and built a large database of results, it should be making better predictions than its competitors. However, the fact that it plans to relaunch its concept-testing product later in the year may bring that assumption into question.

In contrast, Games Workshop, after a decade of setbacks in which the company did not grow revenue at all, has suddenly lurched decisively in the right direction. Having changed almost everything except its cussed determination to do everything its own way, the fantasy toy soldier supplier, best known for its Warhammer brand, may finally have found a path to growth.

Since the company combined revenue growth with record profitability in the year to May 2017, investors should be beneficiaries. Subsequently, Games Workshop has announced that profits in the new financial year are well ahead of the triumphant year just gone. It’s the opposite of a profit warning – an ‘earnings surprise’.

Bias to inaction

Games Workshop’s share price has shot up, but it might just still be a good investment. I won’t add more shares to the portfolio, though, because the holding has increased to more than 5 per cent of the portfolio’s total value. At that level, I’d rather diversify.

System1’s profit warning may be indicative of a significant weakness, and the share price has crashed, but that’s not enough to invalidate all the good things I know about the business. In particular, its fastest growing behavioural product, advertising testing, should still be performing well, and the company’s entrepreneurial culture will probably enable it to stay ahead.

I take my obligation to shield the portfolio from impulsive actions very seriously. When you look at your online brokerage account and see that the price of a share has gone up, it’s probably highlighted in green. When the share price is down, it’s red. My spreadsheets highlight valuations rather than prices, so other things being equal, when the price of a share goes up, the shares become more expensive and my spreadsheet glows red.

When the price goes down, the shares are cheaper and my spreadsheet turns green – it’s the opposite of what happens in many brokerages. Red signals danger and green signals all is well – so if you’re a contrarian like me, your broker might be sending you the wrong signal.

A trader I know takes a different view. His bias is towards action, and his motto is ‘when in doubt, sell out’. He says he doesn’t have enough confidence in his understanding of businesses to hold them through thick and thin.

In contrast, I doubt my ability to instantly interpret bits of news, and I don’t want to waste time and money trading shares if I’m not confident I’m making the right decisions. I note my concerns, seek corroboration and work out the bigger picture. My opinions change, but they change very slowly. My trader acquaintance’s maxim would turn me into a hyperactive trader, or force me out of investing in shares altogether because I know enough about the shares I own to doubt them all.

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