"I like people admitting they were complete stupid horses' asses. I know I'll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn." – Charlie Munger.
When I last had a confession session, my 3 most embarrassing mistakes were basically selling good companies too early, but today, I have to share with you an even worse kind of error…
Indeed, my error broke one of my 4 most important investing rules, because I'd failed to do sufficient research into management. Here's what happened…
I bought a small position in a company called Resonance Health Limited (ASX: RHT) that appeared to have recently become cashflow positive. The $17 million micro-cap owns medical software that uses MRI images for novel diagnostic purposes such as monitoring the iron or fat content of the liver. I thought that since it was on the verge of profitability, operating leverage might kick in, resulting in fast-growing profits. The theory was that growing revenues and largely fixed ongoing costs would result in an impressive profit.
I was subsequently blindsided when the not-yet-profitable little company announced it was considering an acquisition of an even smaller, cash-burning company called VueKlar, with which it shared a director, Jason Loveridge (who does not own shares in Resonance Health). It seemed clear to me from the outset that it would take years and cost millions to commercialise the VueKlar's product, and as soon as I read the announcement I felt in my gut I had made a terrible and embarrassing mistake and I sold immediately after calling a friend to check I wasn't over-reacting.
The announcement by Resonance Health that it was considering acquiring VueKlar saw the share price drop from 5c to around 3.5c – about 30%. The share price has recovered somewhat since the company announced it would not go ahead with the acquisition, around one month later. Apparently, the reason the proposal did not proceed was that Resonance Health would have trouble enforcing patents in the "complex and litigious" IP environment. This should have been clear from the outset, especially given the two companies share a director and similar expertise.
I sold my shares at 4.8c for a small loss, but the damage to my pride was far worse. The lesson is that deeper research can save me money, and there's no excuse for not doing my homework. I believe had I figured this out earlier, I would have been far more hesitant to buy what was clearly a speculative stock.
