Do you recall your most exceptional investment?

And what about your most unfavorable one?

Indelible Memories of Loss

I struggle to reminisce about my best investment. Yet, I vividly recall my most regrettable investment, an episode dating back over 17 years!

This composition centers around precisely that – my most unfortunate investment and methods to avert a similar fate.

This is the tale.

An Astonishingly Undervalued Enterprise

In March 2006, I chanced upon an exceedingly undervalued small firm in the UK using a screening mechanism to unearth inexpensive investment prospects.

Its inexpensiveness was astounding:

• It was devoid of debt
• Its cash holdings equated to 8% of its market worth
• Trading at book value
• With a price to earnings ratio of 6.5 (excluding written off goodwill)
• Over the preceding seven years, it traded at a price to earnings ratio ranging from 5.6 to 7.0 times free cash flow.
• Valued at GBP34 million, in 2005, it repurchased shares worth GBP10.2 million, amounting to 30%! – and
• Based on the previous year's dividend, it yielded 6.5%

Undeniably, it was a steal!

The Initial Purchase

The company was Lambert Howarth Group PLC (Lambert Howarth), engaged in designing, sourcing, and providing footwear, accessories, and houseware products under its brand and licensed labels to retail clients.

On April 26, 2006, I procured my first shares at GBP1.69, the day following the release of the 2005 results.

Two weeks later, the stock dipped by 11.4% subsequent to management declaring that trading was substandard and below expectations. I acquired a few more shares at GBP1.495.

Plummeting Prices – Persisting Purchases

Over the ensuing month, the stock price continued to plummet and I persisted in purchasing – a practice I now never repeat more than once.

A month and a half after my initial acquisition, the stock had nosedived by 44% and I made five additional purchases.

Shortly after, a reputable value investment fund, Intrinsic Value Investors, bought a 4.9% stake in the company. I surmised that I couldn't be entirely mistaken in my analysis.

Naturally, I refrained from further acquisitions without conducting an analysis. Prior to each acquisition, I revisited my analysis, scoured the internet for articles, and reached out to acquaintances in the UK to inspect the stores.

On July 19, 2006, the company divulged that the retail market had not improved since its prior announcement and that first-half sales for the fiscal year were significantly lower than anticipated. Envisaging no recovery in the second half, the company anticipated reporting a loss for the ongoing fiscal year.

Analysis Checks Out

Other than the poor trading results, I unearthed no other discrepancies in my analysis, despite scrutinizing the company from every conceivable angle. Challenging retail conditions were afflicting numerous UK companies, not exclusive to Lambert Howarth.

Astonishing Valuation

The company had plummeted to an astounding valuation level:

• Price to earnings ratio of 3.7
• 50% of book value
• Dividend yield of 14.7%

In late July 2006, under the assumption that I overlooked a critical aspect, I beseeched a trusted friend (an adept value investor) to appraise the company.

He affirmed that despite a sales downturn, the company was financially sound, albeit contingent on the new CEO's eminence. He viewed it as a high-risk, high-reward investment, with the risk mitigated by the company's robust financial standing.

I Persisted – and Plummeting Persisted

I persisted and the stock continued its descent. By the conclusion of August 2006, it had plummeted by over 60% from the initial price I paid, four months prior.

Subsequently, I made my final acquisition at this time, when the stock was priced at GBP0.6525, and the company was trading at a historical price to earnings ratio of 2.5 times, a price to book ratio of 0.4, and a historical dividend yield of 16.9%.

Constituting 12% of My Portfolio

At this juncture, Lambert Howarth composed 12% of my portfolio valued at my purchase price and 6% based on the prevailing price. Despite the 50% price collapse, it still represented a substantial position.

On September 28, 2006, as anticipated, the company reported a loss for the half-year ending June 2006 after writing off significant goodwill. A pivotal fact that contributed to the loss was Marks & Spencer (its primary customer) commencing direct procurement of half the shoes they previously procured through the company.

This was a significant oversight on my part, but more on that later.

Insider Transactions

On October 30, 2006, the non-executive Chairman of Lambert Howarth Group purchased 50,000 shares valued at GBP29,937. It wasn't a colossal wager, but a favorable indication in my opinion.

In March 2007, the company announced progression in its restructuring, disclosed in September 2006, including the appointment of a new finance director.

Though they acknowledged that trading during the initial two months was arduous, they expressed confidence that the robust first-half order book would metamorphose into profitable sales over the subsequent months, offsetting a substantial portion of this deficiency.

Reviewing Strategic Alternatives – A Major Warning Signal

The announcement also stated the engagement of Pricewaterhouse Coopers as the board aimed to evaluate strategic options, potentially entailing equity raising. This was another consequential detail that I also failed to adequately acknowledge.

On May 1, 2007, the company reported a pre-tax loss of GBP16.3m subsequent to goodwill and restructuring costs of GBP6.2 million. The decline in sales by 29% was largely attributed to the loss of half of the Marks & Spencer business mentioned earlier.

Not Entirely Pessimistic

However, it wasn't all bleak, as the chairman conveyed that conditions began to ameliorate towards the fiscal year's conclusion, a trend that continued into the current fiscal year. Additionally, the company persisted in its restructuring, curtailing expenses, and relocating more manufacturing to Asia.

But owing to the abysmal business performance in 2006 and the restructuring,…

The company signaled the need for more capital, expressing the possibility of being unable to continue its operations without additional funding. Unfortunately, I overlooked this significant warning. On the bright side, the company successfully acquired licenses from Radley for women's footwear and from Pringle for both men's and women's leather accessories.

When the share price reached GBP0.51, my investment suffered a staggering loss of 56%. Reflecting on this, I couldn't fathom why I persisted with the investment despite the company's declining performance. In retrospect, I realize that my unwavering stance was fueled by unwarranted optimism, as I placed undue faith in the management's vague positive affirmations.

A pivotal moment arrived when I grappled with the decision of whether to hold or let go. Regrettably, my reluctance to accept the loss was palpable. A loss of 56% on a fraction of my portfolio left me in a precarious position. Instead of cutting my losses, I inexplicably held on.

Cutting to the chase, on 26 July 2007, the company declared its inability to proceed with the planned fundraising due to unforeseen circumstances. Later, it was revealed that Marks & Spencer's potential shift in its procurement strategy played a decisive role. As the situation unfolded, on 13 September 2007, Marks & Spencer announced the cessation of all future orders with Lambert Howarth, further exacerbating the company's predicament. Consequently, on 3 October 2007, citing uncertainty and the cancellation of fundraising, the company was unable to publish its annual report and accounts for the year ended 31 December 2006.

As a dire consequence, the board opted to appoint an administrator in the best interest of the company's creditors, culminating in a complete loss on the investment. The
Lambert Howarth share price graph
Source: Morningstar.co.uk As disheartening as it was to endure a complete loss, the experience proved invaluable, serving as a stern reminder etched in my memory.

Here are some essential learnings from this experience:

1. Always approach management's optimistic projections with skepticism, relying more on concrete numbers than persuasive salesmanship.
2. Exercise caution when considering increasing investments amidst declining prices, ensuring thorough analysis before committing further.
3. Refrain from bolstering your investment in a deteriorating business solely based on historical profitability, considering the fate of companies like Kodak and Nokia.
4. Plan and implement strategies for dealing with potential investment losses, such as a stringent 20% trailing stop loss, to mitigate future risks and protect your portfolio.

Reflecting on this journey, while the journey may have been laden with setbacks, the lessons learned have equipped me with a wealth of knowledge to navigate future investment endeavors more effectively.