Story Stocks and Purplebricks

Here is one New Year’s resolution which investors might wish to adopt: avoid those “story” stocks!

Paul Scott who writes a popular blog on small cap stocks for Stockopedia recently wrote “Above all, this year has taught me to stop chasing stories”. He suggested it was a “virtually guaranteed way to lose money”. He mentioned a few hyped up stocks that crashed back to earth in 2015 including Audioboom, Fitbug, Concha, Tungsten, Rightster and Torotrak. These are the kind of stocks that need repeated fund raisings, often via discounted placings that prejudice existing shareholders.

What are the characteristics of a “story” stock? They often have little or no sales or profits, but a story that is both attractive and plausible. They have a new product or service that sounds like it could be very alluring; or a new way of doing business that enables them to undercut existing market incumbents. The typical message is that they have invented a new paradigm that will change the world as we know it. If they can claim uniqueness, that there is a whole new market they can develop, or that it will devastate the cosy and very profitable businesses of current market leaders, so much the better.

Bearing the above in mind, let’s take a look at a company that just listed on AIM – Purplebricks (PURP). You can of course read the prospectus which is on their web site which tells you what their story is. I summarise it below.

Purplebricks is an on-line estate agent. You might say there are already a number of those who are claiming to sell houses for lower fees than traditional estate agents and you would be right.  The current market share of Purplebricks is not made clear in the prospectus. It says it is differentiated in that it is actually a “hybrid” model which they suggest is more attractive to customers – they “engage” local property experts (LPEs) to handle such matters as doing valuations which cannot be done solely in the virtual world of the internet. Most of these LPEs are franchised by the company.

The company claims to undercut the traditional estate agents’ fees that average £4,000 to sell a house with a fee that is more like £1,000.

Other claims are “first mover advantage” with their hybrid model, an improved marketing strategy focussed on TV advertising and higher spend on marketing, good market share momentum and a strong management team.

What do the financials look like for this investment (which is often the last thing people look at for “story” stocks)? To the five months ending September 2015 they achieved revenues of £5.7 million and an operating loss of £4.9 million. They spent £5.1 million on media costs alone! The comparable period in 2014 resulted in revenue of £598,000 and losses of £2,034,000 so you can see how they are ramping up the business by aggressive marketing. When will this business make a profit? Kate Burgess in the Financial Times suggests that analysts don’t expect it to turn a profit until 2018.

The directors of this company can of course argue that the existing estate agents market is quite fragmented with lots of small local businesses although there are some larger chains. These businesses are already generating a lot of their new inquiries via the internet – via Rightmove, Zoopla and others who will not be affected by these new entrants because they will be using the same “portals” to generate sales.

It is of course historically a market where trust is low. Estate agents typically rank only just ahead of used car salesmen in the public’s view of their trustworthiness, so perhaps there is room for a new business model that can change that perception.

And what was the valuation put on this business by the IPO? It was about £240 million. That’s about 13 times the likely revenue in the current financial year. That’s not bad for a business where the losses almost match the revenue, which are both growing rapidly, and where a clearly profitable business model has yet to be established. My experience tells me that it is easy to generate sales growth if you spend as much on marketing as the revenue generated, as in this case. Needless to say that from the placing of shares as part of the IPO, existing shareholders received a net £32 million with only £23 million being raised for the benefit of the company. You can expect other similar businesses to float in the near future as their founders see what valuations can be put on such unprofitable companies.

So if you are encouraged to jump on this bandwagon, just remember to get off at the right point.

Roger Lawson

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