What my biggest investment mistake teaches us about the software sell-off

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The recent sell-off in software and so-called “quality growth” stocks is reviving some painful memories for me.

Big drops this month in the share price of IBM, Salesforce and, in the UK, Rightmove, are based on the fear that Al tech will not boost their operations, as many had initially predicted, but will instead eat them for breakfast.

It takes me back to my biggest investment mistake — an understandable, but costly, error and one that has haunted me for nearly 30 years. There are some lessons I learnt from it that are pertinent to the current situation, though, so for your benefit, I will relive my pain. 

It concerns the Yellow Pages. Launched in Britain in 1966, it was a big, chunky volume that you kept by the telephone. It listed all the phone numbers in a region by trade and was delivered to your door. The company made healthy profits by persuading business owners to pay for bolder entries so they would stand out. 

And then came the internet. Many companies believed to be internet winners ended up as internet toast within a few years. Revenues held up for a while, but the market — in the way it does — anticipated the challenges, and the shares started performing badly well ahead of the cash flows sinking. 

In 2000, the bubble in telecoms, media and technology stocks burst, but businesses continued to incorporate the internet. I thought that Yellow Pages, quoted as Yell plc, could benefit. It was not completely stupid. After all, huge print and distribution costs would be eliminated, and Yell’s branded online site would surely be where we all looked for traders. I hadn’t accounted for Google!

The shares malingered. I compounded the problem by buying more when they had fallen a fair bit. Eventually, Yell went bust along with its elder US sibling. It remains my largest loss in stock selection over 26 years, but today I find myself applying three lessons:

1. Be ultracritical: When shares you own sink, assume that you’re wrong rather than looking for reasons why you’re right. Buying more is tenable only if you’ve thoroughly reviewed and reconfirmed your original investment thesis. 

2. Value a company on tomorrow’s earnings: When technology or other changes weaken the barriers to entry or undermine demand, reassessing a share’s value based on yesterday’s earnings is dangerous. Those historical earnings could collapse, taking future profits with them. Factor this into your calculations and allow prudent leeway.

3. Diversify: The more exciting a sector is, the more uncertain its future. A larger number of smaller holdings might make better sense than a small number of all-or-nothing calls.

These lessons are proving particularly helpful in current market conditions. We might conclude that the barriers to entry for new software writers have reduced more than anticipated. This is an industry where…