I know very little about investing in the stock market (and have never done so IRL), so apologies if this is not a meaningful question, but: Is there a name for an investment strategy that looks out for strong, robust companies that have just got rocked by terrible news, then investing at that point as the share price plummets? Or if it doesn’t have a name, is this a recognisable strategy in investing?
I was thinking about this following the crisis of the UK building society Northern Rock, which has just approached the bank of England for an emergency loan on account of the fallout from the US sub-prime mortgage market. Share price is down 35%, story here .
This is maybe not such a good example, as I don’t think Northern Rock would be most people’s idea of a blue chip, robust company that is sure to see off a crisis. A better example would be Merck, whose share price got tanned following the vioxx controversy, when it went down 40% in 2004. Apparently it is back up past pre-2004 levels - see here . I’m familiar with the pharma industry, and it seems a no-brainer to me that a company with the size, depth of talent and resource of Merck would pull though something like this. Famous last words? or do I need to start investing on this stormcrow model?
Maybe someone could give counter examples where a highly respected company got put on its back and just never got up again.
Yeah, some people might have stumbled upon it a while back.
As for your question, It’s just another variation on “Will I be able to predict the future?” , to which the answer would be “If you can, you’ll do well to keep it to yourself”.
To answer your first question, many people would call it “value investing” – you find a company whose value you feel confident about, and when you’re sure it’s undervalued, you buy it up, effectively getting more shares for your dollar. If you plan to sell as soon as the value levels off again, locking in an aggressive short-term gain, you might call the strategy “market timing”. If you are a buy-and-hold kind of person, you can effectively pursue the strategy you’ve described on a micro scale by buying the same dollar value of a stock every month or every week; when it’s up, you’ll buy fewer shares, and when it’s down you’ll buy more. That’s called “dollar cost averaging” and it’s a great long-term strategy for buying.
You’re going to see a lot of big-name companies weathering some serious pain in the next few months as the chickens come home to roost. If you think they’re going to survive this mess, it might be a good time to get in to the market.
It’s called a “falling knife.” Somebody (Peter Lynch?) once compared the strategy to trying to “catch a falling knife.” Sometimes it works, sometimes not, but it’s always dangerous.
The classic advice is “Buy on the rumor, sell on the news.”
The logic: If you hear of a pending merger for example, the rumor stirs interest. The more people who notice a stock, the more who want to buy, which pushes up the price. Once the item is done, it will fall out of the news and buyers’ attention will be elsewhere.
That advice applies to good news. The OP was asking about bad news.
To the OP: The general attitude is that the market overreacts to news, both good and bad. So a company beset by surprise adverse news will see its shares oversold & the price over-reduced. But by how much and for how long?
Your example of Vioxx is nstructive. Merck will be spending many millions, if not a whole billion, in legal costs & management distraction for a decade or more getting out of that mess. Those are real costs with real impact on the overall profitability of the firm. Meanwhile, they will not be recieving the rich income stream from the 15+ year patented life of Vioxx that was priced into the pre-bad-news share price. That is a real reduction in revenue.
So the price logically should fall on the news. And logically it ought to rise again as the problem is worked out, lawsuits settled, fines paid, and replacement products (& their revenue stream) brought online.
But as the company recovers, will the shares outperform some other shareholding you might have bought with the same money?
Generally what you’re describing is known as “shorting the stock.” That’s one way you can profit if a share price drops (there are also various option strategies that can work for you).
You make money by buying 100 shares at $50 a share and immediately selling it. You now have $5000 in your brokerage account. The stock then drops to $30. You buy 100 shares ($3000) and return them to the lender. You’ve made $5000-3000 = 2000.
The trick is to pick the stock that’s about the drop; that’s the difficult part.
As far as I interpret the OP, this is the answer. There are many, many mutual funds that follow this strategy. They’re generally referred to as following a “value strategy.” But the managers of these funds are also called contrarians.
I have one fund that follows a rigid value philosophy. It will only buy a stock when the managers believe that the price has fallen significantly below where it really should be. For example, one mining stock in the fund was hit with a cease operations order from the government of the country where its biggest mine was located. The general market panicked and the price of the stock dropped 20%. The fund managers, however, contacted all of their sources (people that you and I simply cannot get in touch with) and learned that the closure would be very temporary, until a small clean up had occurred at the mine site, or until the correct palm had been greased. So they didn’t sell. In fact, they bought more, because the stock was now undervalued by the market. Some would call the managers value investors, some would call them contrarians, some would call them opportunistic, and some would even suggest that such closures were fabricated by savvy insiders to drop the price temporarily and manufacture instant profits.
Whatever you call it, the strategy you described certainly exists, and many mutual funds are built on it.
Second what Lunar said. The most famous value investor alive today is probably Warren Buffet. The Wall Street Journal reports he just floated a big bond sale in order to invest in real estate…on the heels of the subprime meltdown.
I’m pretty sure he wasn’t describing selling short. Watchman sounded like he wanted to buy into a company that had just been rocked with bad news. One could call this a form of value or contra investing, though it is pushing the envelope on the definitions.
Yes, it is pushing the envelope somewhat. To take the example of a value mutual fund, the managers and analysts at the fund simply do scads of research, a lot of it technical, and buy only stocks that they believe are undervalued by the market in general. They do a ton of research about, say, IBM, and come to the conclusion that given the current business and economic climate and the probable future business and economic climate, there’s just no way the stock should be valued at $65. They feel it should easily be worth $82, with a chance of eventually going to $100 or higher, and they believe that the collective wisdom of the market will eventually prove them right, so they buy some. That’s pretty standard value investing.
In general, value investing doesn’t just mean waiting around for bad news and then leaping in to buy. That is a form of value investing, because you’re buying stock that’s undervalued (for whatever reason), but it’s certainly far from the only type of value investing. As far as I know, many of the value funds out there are fairly conservative and don’t always leap in to buy whenever a company is rocked with bad news. Some value funds, however, are more aggressive.
I have done fair-to-middlin in the stock market the past 15 years.
Here is my experience that has worked for me:
First off, there is two overall different styles of investing. There is the investor that learns all about the company…looks at balance sheets…does many calculations etc. This I’ve heard as the ‘Fundementals’ Investor. He feels that by learning more information he will have an edge and pick relative winners.
The other type feels that there is no way that he can learn enough about the company to get an edge…that there is too much insider stuff going on and/or the information out there is too fuzzy and out-dated to matter. What can’t be disguised is the historic price movements of the stock. I’ve heard these called ‘Technical’ investors. These people pour over many graphs looking for ‘good’ ones.
I am the latter type.
To answer your question on good news/bad news…this is important but not in of itself. What matters is how the price MOVES in regards to this news.
The best situation is the news (and this applies to the overall market as well as individual stocks) is DOOOOOM AND GLOOM…BAD BAD THINGS ARE GOING TO HAPPEN…but the stock hangs in there or even moves up…then it has strength. Even with bad news, it is holding/gaining. What happens when the bad news goes away? Well…it’s like a heavy weight comes off the price and it can spring up.
Bad news and the stock not holding up? STAY AWAY!
Good news and stock going up? Can’t say anything…don’t buy…find something else.
Good news and the stock holding steady or falling? Don’t buy…what happens when the good news goes away? It could fall rapidly. If you are a short seller…these are the ones to look at.
It is amazing how often the above works. When gas hit $3 a couple years ago…everyone said prices will hit $5 $6 and more. Articles in the news DOOM AND GLOOM. I predicted prices would fall…and they went back to $2. THEN…everyone talked about it going way back down…so I thought they would go back up…and they did.
It seems to work…so I follow it.
FWIW…the economy and political news is pretty gloomy right now…but the markets have held out very well. There was even 2 serious attempts at a downturn…but they are holding.
The OP referred to Northern Rock, which has been the subject of enormous speculation and rumour in the UK. On the negative side it could be wound down and stock-holders’ value will be close to zero, on a positive side it could be bought by another bank for a premium over it’s current share price. It has a negative goodwill rating and (arguably) a dubious mortgage book. An investment site I frequent has 1% of posters buying this stock. Not for the faint-hearted.
