Money Australia — May 2017

cocktail of factors leads to disaster more than any

other: overpaid management, too much debt and

an overvalued share price.

Assessing management’s capability and honesty is

arguablythemostimportantofthethreefactorsbut

it is also the most subjective. The giveaways may be

subtleties in language or unusual behaviours – none

of which may be important on their own but together

tell a different story.

In December 2014, the Intelligent Investor analysts

went to Unilife’s annual shareholder meeting – strictly

foreducationalpurposes.Almostallofuswerereaching

for the smelling salts before the presentation was over

and, as one colleague later put it, “more red flags were

flyingoverthecompanythanata1960scommunist

rally”.WecalledoutUnilifeasoneofourtopstocksto

avoid just a couple of weeks later when the shares were

stilltradingat58cents(thesharepriceisnowunder1¢).

The first red flag was overly promotional language –

Unilife’s chief executive used phrases such as “explosive

growth opportunity” followed by “you can’t make this

stuffup”.Goodmanagementstendtousematter-of-fact

language and don’t sugarcoat bad news or consistently

blameitonexternalfactors.Anythingelse,andinmy

experience, it might suggest management is not being

straight with you.

Other things to be wary of include management

talking endlessly about industry trends or the potential

market size, rather than the specifics of the company’s

strategy or product. Also watch out for too much jargon

in presentations – some managements bamboozle

shareholders with complexity.

Theexcessiveuseofstockoptions–whichquietly

transfers the company’s ownership to insiders – also

seems to me to be a well-trodden path to bigger problems.

In particular, be suspicious of no “high watermark”

Having

named

Unilife as a

top short of

2014–and

its share

priceisnow

down 99%

• Intelligent

Investor

used three

filters

to avoid

disaster

H

aveyouevernoticedthatwhena

company pays its executives more

thanitearnsinrevenue,ittendstodo

really well? Me neither. Management

compensation is one of the first things

I look at when analysing a stock because it does a great

jobatshowingwhotheexecutivesareworkingfor.It

makes me wonder if they are managing the company for

the benefit of shareholders, or are they more interested

in lining their own pockets.

In2012,thechiefexecutiveofUnilifeCorporation,Alan

Shortall,waspaidasalaryof$US420,000.Stockawards

and options, however, bumped his total remuneration

to over $US6 million – in a year when the company

madejust$US5.5millioninrevenue.Then,in2015

whenthesyringemaker’ssaleshit$US13.2million,the

combined remuneration of top management reached

$US13.8million.Alarmbellscomeinmanytonesbut

this one was crystal clear.

ThecollapseofUnilifehasbeenoneofthisyear’s

most spectacular corporate disasters. $10,000 invested

in the company in early 2015 would be worth around

$50today–a99.5%fall.

When investing, you don’t have to do many things

right to earn a decent return but you do need to avoid

trainwreckslikeUnilife.AsWarrenBuffettlikesto

say, the first rule of investing is never lose money; the

second rule is never forget the first rule.

HOWTOTUNEYOURRADAR

So how do you sidestep the next Unilife? Picking

failures is a different ballgame from picking

winners.Youcanalwaysmakeargumentsthata

stock is worth substantially more than its current

share price because you’re valuing an unknowable

future. However, we’d like to suggest one particular

SHARES WARNING SIGNS

STORY GRAHAM WITCOMB

Spot the

next blow-up