Rule number 1: don't lose money

With the markets having a few wobbles I thought it a good opportunity to ponder what happens to investments when share prices drop.

A certain Mr Buffett with his folksy wisdom often wraps deep insights into absurdly simple language. He insists that the first rule of investing is to not lose money. And that the second rule is not to forget rule one. Clearly losing money is never fun, but we can recover this fairly quickly if the price picks up, can’t we?

The table below illustrates why Buffett’s words are key:

Loss	Gain required to breakeven
-10%	11%
-20%	25%
-30%	43%
-40%	67%
-50%	100%
-60%	150%
-70%	233%
-80%	400%
-90%	900%

It shows us that a loss of 10%, needs an 11% uplift to get back to where we started. No problem. But a 50% loss requires a 100% gain to recover the loss. Percentages can be a little slippery, so to put it into more concrete terms:

Starting investment value = £100

10% loss = £10

New investment value = £90

A 10% increase of the new value of £90 only takes us to £99, not the original £100. For this we need an 11% uplift.

Starting investment value = £100

50% loss = £50

New investment value = £50

A 50% increase of the new value of £50 only gives a return of £25 so only takes us back to £75. To get back to the original £100 we need a 100% increase.

A chart shows these nasty consequences clearly:

We can use the same arithmetic to get another perspective on gains and losses:

Starting investment value = £100

Gain of 100% = £100
New investment value = £200

A loss of 50% = £100

Taking the value back to £100

A more dramatic example in my view is the 233% gain in the chart above, which needs only a 70% drop to wipe out all of the gain.

A google sheet is available here with this chart and some sample calculations.

A significant loss recorded against an investment could therefore take a while to get back into positive territory. But also a significant gain could be wiped out with what appears to be a much smaller loss.

Based on the above, losses can have a disproportionate impact on gains, and a portfolio. And it should be evident that a see-saw of gains and losses would end up with an investment losing money. The extent to which this could happen is modelled in the chart below. This shows the result of a successive gains and losses of 10% iterated 100 times.

The values start at 100 and drift slowly down to 60.5, despite the percentage gain being the same 10% gain or loss each time.

The trend is clearly downward. This is simply because the loss is always calculated from a larger number than the gain. This would be the same for any consistent repetitive gain/loss over time.

Of course the stock market doesn’t behave like this and the impacts are not played out like this. However, it is hopefully enough to give pause to also focus on avoiding losses in addition to making gains.

January 2020 portfolio update

The UK markets were drifting sideways during the start of January, and US markets predictably continuing their upwards march. Then everything went a bit George Romero with the appearance of  Coronavirus. Shares started getting sold off in what appeared to be a rather indiscriminate way, but with Asia exposed equities bearing the brunt.

If the news media are to be believed, we have an impending apocalypse, so share prices are the least of our worries. Perhaps a more likely scenario is a short-term health scare that is resolved over the next few months. If a few bargains present themselves I might as well indulge, after all if we return to normal, I'll have bought some shares at a discount. If the end is nigh, it won't matter anyway, checking my portfolio is likely to drift down the to-do list in favour of barricading the windows and hunkering down over my last tin of beans.

Portfolio performance 
The portfolio was down -0.6% in January, losing less than my chosen benchmark the Vanguard FTSE All Share Accumulation which was down -2.8% over the same period.

Best performers this month:
National Grid +7%
Fulcrum Utilities +7%
AB Dynamics +5%

Worst performers this month:
Craneware -26%
SAGA -21%
888 Holdings -18%

January share purchase: NICL
AIM listed soft drinks company Nichols (NICL) joined the portfolio this month. Nichols have a portfolio of products, the most iconic of which is Vimto. They have sat on the watchlist for a while, and my interest began to perk up when the share price started drifting downwards after bumping against a previous high point. Then just before Christmas the company released an update stating that in one of their markets, the Middle East, Saudi Arabia and UAE were applying a 50% tax to soft drinks. The share price predictably tanked by around 20%. Given that this region generated just under 7% of revenues in 2018/19, it seemed a typical market over-reaction.

Nichols have some great operating numbers: ROCE over 20% in each of the last 10 years, along with double digit net margins, no debt, plus a dividend well covered by free cash flow that has increased by an annualised 13% over the same time. They have been able to generate these sorts of returns by outsourcing the production of their main brand - Vimto - and by doing so greatly reduce the capital requirements of the business. Vimto is also licensed for production in other confectionery products, again with minimal capital.

Revenues and profits have been ticking upwards over recent years, while the share price has remained fairly flat, possibly due to it getting an excessive premium which it needed to justify. The Middle East taxation issue shouldn't put too large a dent in either top or bottom line, even with a bit of additional marketing in the region. 

The business was founded in 1908 and was listed on the AIM market in 2004. John Nichols, the grandson of the founder of the company remains on the board as Chairman, and owns 2m shares which amounts to a 5.5% stake in the company, worth around £27m as at the time of writing. Other members of the family also own shares and are employed by Nichols, so they have an interest in ensuring the ongoing success of the business.