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The pain might not be over for Forge shareholders

The performance of the Forge (ASX: FGE) share price yesterday shows the share market at its most brutal.

Shares that closed at $4.18 on November 1st (before they were suspended from trading) reopened yesterday at a fraction of that price, trading as low as 28.5 cents – a 93% loss – before recovering to close at 68.5 cents – a decent recovery, but still 83% below the previous closing price.

If you had $10,000 worth of shares on Wednesday afternoon, you were left with $1,639 last night.

Forge shareholders have my sympathy – yesterday would have been tough. And if anyone tells you that investing in shares can’t be risky, just point them to the missing $8,361 as proof that it can be.

The risks we take

Of course, basing your assumption of all share market risk on just one company’s experience is a little like saying that eating is risky because some people choke.

Instead, as Warren Buffett suggests, “Risk comes from not knowing what you’re doing”.

That’s cold comfort to those Forge shareholders who are nursing one heck of a financial hangover this morning (though perhaps they’re comforted somewhat by a further bounce in the company’s shares this morning).

But <as I wrote> (http://www.smh.com.au/business/take-care-picking-bargains-from-mining-boom-scraps-20121010-27cau.html) over 12 months ago:

“Like the miners themselves, though, the mining services industry might find itself all dressed up with nowhere to go. You can name your price when you have your pick of the projects, but when the worm turns, profit margins come under severe pressure. We’ve seen that happen in the infrastructure and construction sector – with severe consequences.”

And:

“In hindsight, some of those companies may be screaming bargains today. Or not. I don’t know how investors in these sectors can comfort themselves that there are better times ahead. It’s possible, but if you’re wrong, it’ll be devilishly hard to make back your losses.”

The more things change…

That’s the message we’ve been giving Motley Fool Share Advisor members now for well over a year. Sometimes a company looks cheap – but that’s different to its being undervalued.  The string of mining-services downgrades should have been warning enough for Forge shareholders – and indeed for shareholders of other mining services businesses – to be very careful indeed.

The story, though, <remains the same> (https://www.fool.com.au/2013/11/20/why-would-you-buy-banks-when-there-are-160-winners-like-this-to-be-had/). I could just as easily repeat the second paragraph of the quote, above, today.

Sure, mining services companies have fallen a way since I wrote those words in October 2012. But the problems for investors remain. Who of us can confidently predict the direction of these businesses from here? New mining investment remains down; in fact, yesterday’s ABS data showed that plant and machinery investment by miners was down 30% between the September 2012 quarter and the same quarter this year.

Value… or a value trap?

Falling prices are seductive. We all like to nab a bargain. Maybe history will record November 2013 as the absolute bottom of the market for mining services companies – or maybe there’ll be worse to come. And even if the industry does recover soon, there’ll likely still be winners and losers.

Nothing in investing is certain. By definition, we’re all buying shares today with the hope that they’ll be higher in the future. But sensible investing is built on a rational interpretation of the probability that you’ll be right – and a solid understanding of the downside. From my reading of the Forge announcement yesterday, shareholders are fortunate that the company came to terms with its lender, ANZ, or there may not have been anything left at all. That’s a hell of a lot of (potential) downside.

Foolish takeaway

Like any enterprising investor, we’re digging around mining services to see if we can get enough confidence to recommend one to our members. Prices certainly look cheap, but then so did Billabong shares as they fell from $16 to 16 cents. We’re all experts in hindsight, but plenty of people got burnt by blindly hoping that ‘surely they can’t go any lower’.

For investors, especially investors in businesses with uncertain futures, shares certainly can go lower… and in many cases, they will.

Foolish, dividend loving investors who are looking for Australian investing ideas can click here  http://www.fool.com.au/free-stock-report/3-rock-solid-dividend-stocks/?aid=4642&source=add777edial0001 to request a Motley Fool free report entitled Secure Your Future with 3 Rock-Solid Dividend Stocks.

Scott Phillips is a Motley Fool investment advisor. You can follow Scott on Twitter @TMFGilla.

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