In my research and investing I stress three things: people, structure and value. I look for companies that are controlled and managed by quality people, have corporate structures that align minority and majority shareholder interests and trade at valuations that are below fair value if not outright cheap. This post touches on all three and is about one of my worst investments– at least so far
“We learn nothing from our winners”, was how popular market commentator and interviewer extraordinaire Barry Ritholtz put it on a recent Masters in Business podcast (see here). I’ve read similar things in other investment books and articles. It basically boils down to the fact that nobody’s perfect and that it’s best to learn from your mistakes. Traders I know call it tuition. We need to pay money (lose) in order to learn a skill.
Warren Buffet’s partner Charlie Munger, put it another way: “It’s a good habit to trumpet your failures and be quiet about your successes”. This blog post is me tooting my own broken, bandaged, tail-in-between-my-legs, trombone.
I wrote about Ukraine in two posts. They were based on my February 2014 trip to Kiev (see here and here). I came away from my trip thinking that the uncertainty caused by the Ukraine/EuroMaidan Revolution marked an economic and stock market bottom. This was not the case and both have fallen even further.
In mixed company and presentations I mostly blame the currency. And numerically that accounts for most of my loss. The Hryvnia declined by 67% vis-à-vis the USD since my initial investments in March 2014. In contrast my portfolio of Ukrainian stocks is down about 50%. The 17 percentage points of ‘alpha’ (or excess returns) is little solace when I’m down by half at a time when other markets have risen.
However the currency decrease hides the fact that I made some real investment blunders. The biggest mistake was not sticking to my investment process. If I had, I would be wealthier and have slept much better.
Here is how I screwed up:
Inexpensive without quality is just plain cheap
I could see from my Hong Kong base that Ukrainian stocks were cheap on almost all traditional valuation metrics. The key reason for the trip – indeed all trips – was to determine if the cheap stocks were of any value.
It’s like buying clothes on the Internet. They may look like a bargain online, but if the size is wrong, the material cheap, and the stitching poor, it’s just plain cheap. Cheap is the inexpensive shirt that hangs unused in your closet. Value is the inexpensive shirt that makes you look good and feel confident.
Moving from the cheap to value category is where my people and structure factors come into play. Instead of sticking only to companies run by good people and have simple corporate structures, I invested in companies that were very inexpensive on many valuation measures, but were owned/controlled by people who are not likely to be good to minority shareholders.
One example is the country’s largest oil and gas company, Ukranafta. It was jointly held by the government and the Privat group. The Privat group is headed by Igor Kolomoyskyi, one of Ukraine’s richest men and an archetypical “oligarch”, meaning he has both economic and political power. He has a less-than-stellar-reputation according to Kiev locals who described him in much more colorful terms. Despite this I thought that it being Ukraine’s largest energy company and its cheap valuation made it a good investment. Its shares were at 3x EV/EBITDA when I bought it in early March 2014 (EV/EBITDA is one of many financial ratios used in an attempt to value a company. Generally a low ratio is preferable to a high ratio. More information can be found here).
Since then, the Privat group is believed to have stifled company reforms, blocked dividend payments, and transferred profits out of the listed company and into other group companies. In March 2015 Kolomoyskyi used his privately-funded armed guards to defend against a “raider attack”, after Ukraine’s parliament passed a law that took away Privat’s veto power at the company (see here).
The share price reflects a lot of these problems and is down some 80% in USD terms since I bought a stake. Another way to look at this is that the same stock now has to increase five times for me to just break even.
Sunk cost is cost that has already been incurred and cannot be recovered. In investments it typically refers to irrationally sticking with a stock that’s already gone down despite better choices. If we have committed to something, our brain has a fierce resistance to believe it made a mistake and we are inclined to go down with the ship.
I stayed invested in Ukraine despite Russia taking over Crimea and a bloody war in Eastern Ukraine. As a reminder, almost 10,000 have been killed and over 20,000 injured in Eastern Ukraine, which likely makes it the largest number of people killed in a European armed conflict since World War II.
The old Rothschild attributed-adage, “buy when there’s blood in the streets”, did not work. After spending time and money going there, I felt I needed to recoup my investment. It would have been better to cut my losses, and just think of my trip and expense as tuition.
In fact I increased my investments after elections were held in the Spring of 2014 and the person I thought would do a good job, Petro Poroshenko, was elected.
Reputation / Pride
I was warned about the folly of buying Ukrainian stocks before I went. This only increased my desire to go as I was told the same thing before I went to Greece the previous year. My investments did very well there, with several more than doubling.
Thinking like a trader rather than as an investor, I forced myself to buy stocks in companies I normally would not have, as all the market signs pointed to Ukraine as being the ultimate contrarian play.
I thought I would look like a fool if I missed the boat in Ukraine after telling people I went there. Instead I look like a fool now. A poorer fool.
Listened to others instead of myself
Virtually all the financial people I met there were way too optimistic, especially after the end of the Maidan protests when local brokers really pushed Ukraine stocks. Nobody expected the currency to fall so much despite it being very weak.
Only one investor – a very smart man from Minsk – correctly hypothesized that Russia would not let Kiev get closer to Europe without some sort of response. Even an educational trip to the national museum where I learned that Ukraine was part of Russia for a long time and that it is essentially a Soviet creation, did not dissuade me. Nor did an ex-military friend who correctly pointed out that there is no significant natural barrier between Ukraine and Russia. Locals in Kiev – even those whose first language was Russian – were convinced Ukraine is clearly a European country and would soon be in the EU if not NATO.
Ukraine’s cheap prices and investment success in Greece the previous