With the FTSE 100 trading above 7,700 and the FTSE All-Share also setting new highs just under the 4,250 mark, investors are off to a good start in 2018 and momentum seems to be on their side.
However, we have also seen an increasing number of share price collapses which highlight the perils of backing the wrong horse in an otherwise healthy market.
They say stock markets climb a wall of worry and the length of the current bull run means investors are getting quite jittery when it comes to company announcements.
The market is not reacting kindly to any kind of negative, or even not positive, announcement and there have been crushing falls at Debenhams, Mothercare and software firm Micro Focus off the back of weak trading updates.
None of these have been as high profile as the collapse of Carillion which is a stark reminder that when investing in equities you can literally lose everything.
While Carillion-like failures are thankfully rare, all of these cases show just how hard it can be for stock-pickers to comb the UK market for ideas, especially as nearly 2,000 or so firms are listed and quoted on the London Stock Exchange’s Main Market and the Alternative Investment Market.
While the recriminations are only just beginning over the collapse of Carillion, as politicians debate the merits of the public-private partnership (PPP) and private finance initiative (PFI) model, whether the company should have been given extra contracts in the autumn and whether executive bonuses should be subject to a clawback, investors can immediately draw six lessons from the debacle, which they will be able to apply to stocks from all geographies and sectors.
They are: beware of complexity and try to stick with firms which keep it simple; be wary of companies whose history is littered with sizeable acquisitions; the potentially deadly nature of the combination of debt and thin profit margins; always look at how management is incentivised to behave; why cash flow is more important than profit; and how dividend yields that look too good to be true usually turn out to be just that.
Looking in detail at each of these points in relation to Carillion provides some valuable insight into the collapse of the company and hence what to look out for when evaluating stock market investments.
1) Beware complexity – keep it simple
It is hard to find what operational synergy or overlap in expertise can be found between providing school meals, maintaining prisons, building hospitals or arranging project finance, yet Carillion did them all and it did so in several geographies, not just one.
The very best long-term investments develop a competitive edge – via a technological lead, a brand or market share, for example – and then deepen their core competence.
Carillion was juggling complex, long-term contracts across a range of disciplines and geographies, a feat which ultimately proved beyond it, especially once a small number of big projects went wrong.