Why This 80% Winner for Me Is Still a Bad Mistake

Investing, like all things in life, requires a little bit of luck. Basically, if you buy shares only for a month or even a year, you’d require a lot of luck to make money. However if you plan to hold it for 20 years, luck’s role in the eventual outcome would diminish greatly though it might still exist a little.

The following is a story of me getting lucky, but in the process, it also taught me about the relationship between luck and time.

What did I buy?

I bought into a particular S-Chip in 2012 at an average price of about S$0.08 per share. This was after the confidence in S-Chips amongst the investing public in Singapore had fallen to a low following a number of high-profile scandals related to frauds and accounting irreggularities. Investors were wary of S-Chips and had pushed their valuations down.

The particular S-chip I invested in was trading way below its net-cash value at that time – i.e., the company’s market capitalization was lower than the value of its total cash on hand after deducting all its debts. On top of that, the company had been paying consistent dividends and was trading at just 1 times trailing earnings. To put into perspective what a low valuation the share had at that time, the Straits Times Index (SGX: ^STI) was valued at 8.7 and 10.6 times trailing earnings as of the end of 2011 and 2012 respectively.

At that time, I thought the market had overreacted regarding the whole S-Chip issue and there was bound to be a turnaround in market sentiment for S-chips as a whole in the future. To sweeten the deal, I would even be paid regular dividends while waiting for the turnaround in sentiment. Sounds good right? Wrong!

The share in question is Eratat Lifestyle (SGX: FO8), a men’s apparel retailer in China. A potential red flag regarding the company’s operations first arose in June 2013 when it issued some warrants and non-convertible bonds to a Hong Kong-based finance company, Sun Hung Kai & Co. Ltd.

The effective interest rate for Eratat’s bonds, which have a maturity of only two years, would have been about 16.7% a year. This happened at a time when the company was supposed to have more money in its bank than its entire market capitalisation. Even from just a business perspective (without even thinking about any possible unethical conduct), the logic of borrowing at such high interest rates while having plenty of cash on hand didn’t seem to make much sense to me.

I sold off my stake soon after Eratat issued its bonds and managed to pocket a profit of 80% within a year of “investing” in this company.  However, it was a big mistake on my part to even invest in this company in the first place. My assumptions for investing into the company were wrong: The general market had not overreacted to certain S-chips and Eratat was not really trading below its net-cash value (since there was no cash to speak of in the first place – more on this shortly).

Since January this year, Eratat has been suspended from trading after the company defaulted on interest payments for its bonds. Subsequently, news broke that the cash balance in the company might have been fabricated.

Foolish Takeaway

What is highlighted here is: There are times in investing when we can make money even when we are wrong. Similarly, there will be times we would lose money even when we are right. With Eratat, it definitely was a situation in the former.

This also brought to mind how important the element of time is in being able to largely negate the element of luck, as mentioned earlier.

I was able to make money on the Eratat “investment” purely because I was lucky and the time frame was short (I had sold within a year). If I had stayed invested for the longer term, my investment would now be frozen due to the suspension and I would most likely lose 100% of my capital. It is important to know that although the market can be irrational in the short run, the truth will always catch up in the long run.

It’s also good practice to distinguish between luck and skill for our successful investments. Luck-based investments, while it might make for good memories, cannot be depended upon for continued success. Correctly recognising skill-based investments on the other hand, can help you become a better investor if the process behind such investments are internalised and then repeatedly practiced.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.