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How the mighty fall

The Eddy Groves and ABC Learning Centres’ story is a massive wake up call for novice and seasoned players of the stock market. Debt to equity ratios are really important when the ‘you know what’ hits the fan. And at the moment, any company carrying too much debt is a possible target for short-sellers, hedge funds and even fund managers trying to fix up their returns by mid-year.
Lessons for share buyers
Let’s look at the stocks that have dragged in the big news headlines – Allco, Centro, MFS and ABC Learning Centres. There are more, but these have copped a real trashing from the market. All four had what most would argue are good to great businesses, but they all were straddled with big debts.
For many diligent players, making a case for holding these stocks would not have been too hard. However, being too exposed to them would have been a much tougher story. By this I mean having too much of your portfolio dependent on these kinds of outfits mean you are leaving yourself open to a suck punch when markets become mad, bad and dangerous – like they are right now.
Hedge your bets
Careful brokers or advisers who construct share portfolios for clients like to see a big range of shares in the bag. Some opt for 10 while others might suggest 20 different shares. In the latter case, assuming you have a portfolio of $100,000 worth of shares, means you would only have 5% or $5000 worth of exposure to any of these kinds of shares.
It would be annoying to see your ABC Learning Centres’ share go from $7 plus last year to $2.43 – costing you more than $2000 – but if most of your other shares are more blue chip looking, then your despair would be measured and primarily short-term.
Good on paper
I like a portfolio to have a real blue tinge with the majority coming out of the top 20 or 30 stocks listing on the Australian Stock Exchange.
Personally, I have no exposure to these savagely trashed companies; however, I have sympathy with their owners because the underlying businesses generally look sound.
The harsh reality
And if it weren’t due to silly home lending practices in the US, which infected money markets and created the credit crunch, then these businesses would not be in the headlines today.
But that’s investment life and underlines how diligent you have to be with your investments.
Blinkered vision
Let’s take a quick look at ABC Learning Centres for a moment to see what were the warning signs many shareholders missed.
On the good side, the company’s revenue is more than $500m, the government heavily subsidises childcare and it’s a growth industry. However, growth has been the trouble.
The number of centres in the US has grown from 300 to 1000 in about a year. The debt the company carries has grown from $110m some 18 months ago to close to $1.7bn today.
Share and share alike
Before and after Christmas, a director was known to be selling off big parcels of shares and then the half-year profit came in under expectations.
It was a recipe for a sell off and then the founder, Eddy Groves, told a journalist that his margin loans calls would only trigger at a certain price and that would have encouraged hedge funds and short-sellers to make it happen. And they did!
The highs and lows
This is still a good business and remember, four big Aussie banks kicked in close to $1bn to help Groves bankroll his grandiose expansion plans. Also, the Singapore Government’s Temasek Holdings took 12% of the company last year at a price of $7.30 a share. It trades at $2.14 as this is written.
Danger ahead
Plenty of smart investors could have fallen into ABC Learning Centres. Many might have looked for the signs and got out before the share price fell this low, but they would have been close watching stock price fanatics. You could call them traders or DIY fund managers.
Market trends
Big blue chip companies can get it wrong and be smashed – recall AMP when it was approximately $4 a share after its UK problems – but generally they are smaller headaches. And their share price slumps are often in line with the overall market.
Playing the field
I heard a so-called expert answering questions on radio the other day and one listener asked if he should sell his shares. The ‘expert’ argued the market had been oversold, which many would agree with, though there could be more overselling over then next few months.
The thing that got me mad was that the expert did not ask what shares the guy was holding. Shares are not the same and need to be assessed in terms of their quality and how well they suit your risk profile.
Better safe than sorry

There will be good buying of shares over the rest of this year, but let me recommend that you look for blue chip companies or operations with low debt exposure with great business models. It’s what I think is at the core of the ABC Learning Centres fiasco – of buying shares safely. 

Published on: Thursday, February 28, 2008

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