The risk that companies will lose a large part of their value in a small space of time, or even fail completely, is considerable, particularly in the higher-growth areas of the market.
A number of UK companies have recently got into trouble, hitting investors in many well-known funds.
Yesterday FE Trustnet looked at the importance of diversification in high-growth areas. Here we look at three high-profile disaster stories that underline this point and show that even the best stockpickers can miss the target.
Cupid
The online dating company is currently caught up in controversy over allegations that employees entice users of its free services to pay for subscriptions.
Allegations and rumours started circulating some weeks ago, and the stock lost 75 per cent of its value between 2 January and last Friday, rebounding in the last couple of days to 62.55 per cent off its value at the start of the year, a blow to FE Alpha Manager Giles Hargreave, who had long held the stock in his Marlborough UK Micro Cap Growth fund.
Claims in the Ukrainian media last week saw the stock fall 57.02 per cent in a day.
Performance of stock over 1yr
Source: FE Analytics
Hargreave even told FE Trustnet in December that the stock was one to watch in 2013.
The company has vigorously denied allegations that employees sent fake messages of interest to users, encouraging them to sign up, and has commissioned an audit by one of the big four accounting firms into its customer database management.
The company claims its trading remains strong and it is optimistic for the future.
The stock has been under pressure for a while. Hargreave stood by the company in the autumn of last year as it undertook a series of share buybacks to boost investor returns.
He also said that a takeover bid was quite possible for the stock, which would be good news for existing investors.
While the stock could yet recover, the episode illustrates the potential pitfalls of technology stocks.
Cupid is operating in the booming online economy, but its recent setbacks have shown how fragile success in this area can be.
The events suggest that Hargreave’s principle of keeping each individual holding down to 2.5 to 3 per cent of his portfolio is wise.
Phytopharm
After 17 years of trading, Phytopharm is looking for a buyer for its assets. Last week the company announced that phase II clinical trials of Parkinson’s drug Cogane showed the product to be useless.
The company has ceased all research and development expenditure and initiated processes to sack staff and cut costs while it looks for a buyer for its remaining assets.
The stock lost 81 per cent of its value in three days, hitting Invesco Perpetual and Henderson among other investors.
Performance of stock over 2yrs
Source: FE Analytics
Invesco Perpetual held 56 per cent of the company, which is a minor holding in star manager Neil Woodford’s £12bn Invesco Perpetual Income fund.
Henderson was another substantial investor, although the latter had reduced its holding in the past few weeks.
The company was Henderson Fledgling Trust's biggest holding at the time of its last annual report last year.
The management of Henderson Fledgling is passing to Miton Capital, which intends to merge it with its Diverse Income Trust, and the position has been partly sold down as a result of the management change.
David Pinninger, manager of the International Biotechnology Trust, told FE Trustnet last week that many investors were tempted to invest in small cap pharmaceutical companies due to the huge gains on offer, but that this company’s failure was an example of the pitfalls of such a strategy.
Early trials of the drug, funded by the Michael J. Fox Foundation, appeared to show it was effective, and the stock more than tripled in value in late 2009 on the back of this.
Performance of stock over 4yrs
Source: FE Analytics
Phorm
Shares in Phorm lost more than half their value last week as markets reacted badly to news it had resorted to borrowing money at an interest rate of 20 per cent a year.
The company issued a statement saying that it saw no reason for the share price to react as it had done.
Phorm creates software that records individual browsing habits and delivers advertising to internet users’ browsers on the themes they have been reading about.
It was lauded as a future "British Google" after it floated in 2007, leading to rapid share price gains. The stock grew 116 per cent in the first month after flotation.
It was bought by a number of funds, including the Majedie Investments trust, which had significant holdings in 2008. The trust is headed up by Nick Rundle and Chris Simmons.
Phorm announced the intention to tie up with internet service providers to build its software into their services.
However, the software was criticised for riding roughshod over users’ privacy, while it was revealed the company had conducted trials without obtaining consent.
Investors started to desert and the Government brought in legislation in the Regulation of Investigatory Powers Act to tighten and clarify the law surrounding the interception of web traffic.
The company’s share price suffered a dramatic collapse and Phorm started to focus on markets in Turkey and China instead.
Performance of stock since launch
Source: FE Analytics
Remaining investors received a nasty shock last week and the shares have yet to recover.