Eating our own cooking - part 2

In Eating our own cooking - part 1, James Carlisle and Graham Witcomb discussed their recent trades along with some of the psychological barriers that have to be overcome in order to be a successful investor. 

Here, the rest of your analyst team continues the discussion.

Gaurav Sodhi

I recently bought shares in IT cloud services provider Bulletproof at 23 cents. With the business subsequently raising capital to make an acquisition, I'm putting more money into the idea at 25 cents. Bulletproof is one of two official partners for Amazon Web Services (AWS). It consults, implements and maintains the transition from servers to AWS for a host of businesses and has been doing so for years.

The company hasn't made much in profits so far but earns revenue from moving customers to AWS in the first instance and then generates recurring revenue from managing the service. The cost of hosting on AWS is passed on to the customer and it takes years for competitors to get recognition from Amazon to become recommended partners.

So Bulletproof should be able to benefit from the success of AWS locally. However, this is a fair business at best; it must reinvest in staff to grow so it isn't scalable in the way of a typical software business. But the valuation is attractive considering the growth on offer.

I've also been selling down some of my holdings in gold producers Northern Star and Ramelius lately. Both have risen considerably and I don't want to be over-exposed to the sector. Crappy gold producers can make for okay investments but it's important to take profits along the way. This sector has a habit of nasty surprises.

I lost 50% soon after buying into Ramelius, which has subsequently more than four-bagged on my purchase price. If you're buying unloved businesses, you must get used to watching your investments fall for a time. Seeking to buy at the bottom is a fool's game and one of the worst investing traits.

My next purchase is likely to be South32, a business with few fans. A significant chunk of my portfolio sits in Antares, currently suspended. I bought in around 40 cents and the shares were suspended at 50 cents. If the asset sale is completed, it should leave about $1 in net cash. If not, the shares may well be worthless. It's another example of why you shouldn't over commit to an idea. Rarely do we fully appreciate just how wide the range of potential outcomes is.

James Greenhalgh

Unlike Gaurav, none of my purchases have been in resources stocks but I am becoming more tempted. There is definitely much more value emerging in the big miners than I have seen for many years. I've generally had a policy to avoid the sector but there comes a time when even I am beginning to look at it more closely.

The stocks I've sold recently to raise cash or fund new purchases are generally those that are market darlings or don't look as cheap as they once did. To keep my bank weightings quite low I've been selling down Macquarie Group, mostly bought around the time of the GFC.

I've owned pokie maker Aristocrat for a long time, which has made me feel a little dirty, although not dirty enough to sell it at a lower price. I'm glad to be rid of it at a good price. It sometimes makes sense to sell Holds to switch into more attractive opportunities (within staff trading rules of course).

As for my purchases, I topped up my holding in IOOF in June when the compliance problems arose and the share price fell in what looked like an overreaction. I've trained myself to grit my teeth when stocks are falling and just buy, assuming there's value on offer.

The stock is still below my $9.23 purchase price but at that price offered a dividend yield of 5.4%. If you've bought for income and the issue is unlikely to affect the dividend, why worry what the price does?

Computershare is another company I've owned for a long time. When the company released a profit downgrade with its full year result and the stock fell sharply on the bad news, I jumped in. It's now my largest holding (just).

The staff trading policy helped me here – I would have bought it at a higher price but the delay allowed me to buy cheaper. Sometimes you don't need to be on the ball – waiting a few days when there's bad news can be beneficial. This turned out to be the case with both IOOF and Computershare.

Computershare strikes me as one of those great companies where growth has tailed off and the market is losing interest. But on an 8% free cash flow yield you don't really need any growth, although I think there'll be that, too. And, as mentioned, you don't need to buy immediately after the bad news. Sometimes we get a few weeks or months to buy in. The key is not to finesse it – just jump in around the time the bad news happens.

Trade Me is a new stock for me but the more I got to know it, the more I liked it. I also thought it looked very cheap. If I think a stock's very cheap and the company is close to releasing its result, I tend to wait. Even if the news is not as bad as expected, the stock rarely jumps much on the relief, as Trade Me proved. The important thing is not to anchor on the price before a result. If the news is good (or not bad, as in this case) and the stock looks cheap, just get on with it!

Seek reported a profit downgrade with its result so once again, bad news was the catalyst. I was a bit concerned that the stock, because of its high quality, might recover quickly but it didn't.

I presented it to the team in a Dragons' Den where it earned an upgrade and bought once the trading rules permitted. The price has eased a little since the downgrade, again suggesting you have a reasonable period to act after bad news. But you mustn't anchor to the lowest price over this period. If you do your work and it looks cheap – even if it's rebounded off the lows – then buy it.

Don't tune out the scary headlines either because that is what is creating the opportunity. While there is a risk that a recession might hit Seek, good businesses tend to be resilient and not fall as much as you might expect. This has been a big lesson for me – quality businesses really do seem to outperform. Worrying about economic or external worries is a recipe to miss owning great businesses.

Finally, I try not to worry about missing out on some stock opportunities. Virtus was one. As with Trade Me, I wanted to wait for Virtus's result. In this case, though, the stock jumped sharply over successive days. The pullback never came and it got away from me. Such is life.

Jon Mills

Unlike the rest of the team, I haven't made any sales recently. This is because I own a fairly concentrated portfolio and am still building it up since returning to Australia two years ago so I haven't needed to sell current holdings to invest in other stocks. 

In terms of purchases, one of Ben Graham's more famous quotes is 'in the short run, the market is a voting machine but in the long run, it is a weighing machine'. As we've seen with the market's reaction to Seek's result, 'voters' dislike slowing profit growth and especially dislike profit declines, however temporary.

This gives us the chance to pick up fine businesses as we've done in upgrading Seek to Buy (although it's now above our Buy price). To me, Trade Me is another opportunity and even better, unlike Seek, it's still well below our Buy price. 

One of the reasons for the stock's decline earlier this year was the fall in the New Zealand dollar, which reduces Trade Me's earnings in Australian dollar terms. I can't predict future currency values but changes in currency become less of a concern the longer you hold the stock.

Of more concern to investors – thus providing the opportunity – is the substantial investment by Trade Me in its websites and mobile offerings. Although revenue has continued to increase at a good clip (12% compounded over the past five years), costs have increased much faster as management further increases the value of Trade Me's sites to customers. This should further improve its competitive position and pricing power.

Australia's equivalents – Seek, Carsales and REA Group – have all gone through this process earlier in their corporate lives so Trade Me is following a well-trodden path. As cost increases slow, margins should increase and its increased pricing power should lead to more cash being extracted from each customer transaction.

While potential competition from a well-funded competitor is a risk, at 15 times earnings, I felt I was buying a very good business for a fair price. The price could become a great one, however, if the above comes to pass.

I'd also been interested in purchasing assisted reproduction provider Virtus ever since we first upgraded it to Buy in Virtus and Monash claim to deliver on 8 Sep 14 (Buy — $7.85). I got more and more interested as the price continued to fall but in such cases I always try to ask myself what the market knows that I don't.

As noted in Virtus and Monash claim to deliver, one known risk was the Government further reducing IVF subsidies. Even so, any shareholder pain from this would likely be temporary – and an opportunity to increase your holdings – as demand for IVF services likely resumes its steady increases over the long term.

As even more prominent known risk was the entry of low-cost, bulk-billed competition from Primary Health Care, which led to a profit warning from Virtus earlier this year. But as colleague Graham Witcomb explained in The stocks I've bought are tumbling. What now? - Part 2, there are many reasons why Primary Health Care's offering won't lead to the death of Virtus.

Yet in the lead up to its 2015 result, the price continued to decline, falling under $5. This made me once again worry about what I didn't know but, after again reviewing the investment case and the risks it was wrong, what made me pull the trigger was compelling value. At a double-digit free cash flow yield, the risks appeared to be more than priced in.

Virtus is a business with low reinvestment requirements, high returns on invested capital, and economies of scale which, along with only around a dozen new fertility specialists being trained each year, means it operates in a market which is difficult for new players to break in and quickly gain scale.