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3i (LSE:III) is one of my favourite UK stocks. The FTSE 100 private equity company has just about everything that I look for in a stock investment.
The stock has been doing well this year, but it fell 18% in a day on Thursday (13 November). I can see why, but I don’t think there’s much wrong with the business, so I’m looking to buy big.
Buy the dip?
When stocks fall, it can be a great opportunity for investors to buy shares in quality companies at relatively attractive prices. But there are some golden rules that I always try to stick to.
One of these is that I never buy a dip if I can’t figure out why it’s happening. The stock market isn’t 100% efficient, but it also doesn’t just send stocks lower for no reason.
A big move in a stock is almost always a reaction to something. It might be an overreaction – that definitely happens – but I think buying without knowing why a stock has fallen is hugely risky.
So why did the stock fall so dramatically after the firm’s H1 earnings report on Thursday? While some people are pointing to an uncertain outlook, I don’t believe that’s the real reason.
Why is 3i down?
The CEO did indeed warn of an uncertain macroeconomic outlook. But as my fellow Fool writer Harvey Jones has pointed out, that shouldn’t have been a surprise to anyone.
I think the real reason the share price crashed is a disappointing set of results from Action – its largest subsidiary. The retailer recorded like-for-like sales growth of 5.7% since January.
There are a few problems with this. The biggest is that it’s well below the growth rate the firm has been achieving in previous years, which has regularly been above 10%.
This is made worse by the fact that 3i values Action at a punchy 18.5 EBITDA multiple. Add in the news they’ve been increasing their stake at that level and the reason for the crash is clear.
Why I’m buying
Action’s recent performance is a clear illustration of the risk associated with 3i shares. But the company still stands out to me as a strong business with a durable competitive advantage.
Elsewhere in its report, the firm announced it was preparing to sell two of its holdings. One is a pet food business called MPM and the other is a software operation called MAIT.
It’s set to realise a 220% return in five years on the former and a 180% return in four years on the latter. That’s outstanding at a time when other private equity operations are struggling.
The key is that 3i invests its own cash, instead of raising capital from external investors, which lets it invest on its own timeline. That’s the firm’s big advantage and I don’t see it going away.
Foolish thoughts
3i’s results demonstrate the risks associated with a concentrated portfolio. But the thing that sets the firm apart from its rivals is its ability to be selective about opportunities.
That comes from investing its own cash, rather than raising external capital. And with this positive still very much intact, I’m looking to use the recent big drop as a chance to buy the stock.