Recognizing Value Situations - The Fire Sale
Occasionally companies experience deep price declines due to actual or anticipated news or announcements. These declines can get out of hand, as more and more bad spin circulates in the market and investors (and institutions) head for seemingly safer waters.
The decline is either a one-shot affair or a longer, momentum-driven decline.
The one-shot affair is usually more attractive to the value investor, as it is often more of a short-term overreaction to news than a fundamental shift in the business.
Getting creamed
The one-shot hit was recently exhibited by company XYZ. Even though XYZ has no debt, pays a dividend (rare for a small cap growth stock), and has over $5 in net cash, the stock lost 40 percent of its value, from $28 to $16 over three trading days with concerns about the economy and an ambiguous earnings outlook (the quarterly report actually beat expectations).
The shrewd value investor doesn't just go out and buy; he or she researches a situation to determine whether the business model really is broken. Running the numbers, visiting the stores, and researching the industry are all appropriate steps in this situation.
Anytime a stock loses a quarter, a third, or half of its value in one day, it may be worth a glance. Just keep in mind that the reasons for these slaughters are sometimes justified, and the road to recovery may be difficult. There may be more touble than meets the eye. At the same time, a value investor may find bargains among such distressed inventory.
Misreading the tea leaves
Longer declines are illustrated by nearly the entire telecom and fiber optics sector in the 1998 - 2003 era: Long, slow persistent declines driven by ever increasing negative sentiment. The reasons are fairly obvious considering the history of telecom deregualtion, the Internet boom, over-ordering, excess capacity, excess expectations, and subsequent bust. But still, most market players were focused on the short-term write-offs, layoffs, and lack of visibility; few looked at the long-term prospects for these businesses. These bust cycles happen all the time. Some are company-specific; others are inherent in their industry. Widespread negative sentiment can produce attractive buying opportunities.
Also read:
Recognizing Value Situations
Recognizing Value Situations - Growth at a Reasonable Price
Recognizing Value Situations - The Fire Sale
Recognizing Value Situations - The Asset Play
Recognizing Value Situations - Growth Kickers
Recognizing Value Situations - Turning the Ship Around
Recognizing Value Situations - Cyclical Plays
Recognizing Value Situations - Smoke and Mirrors
Keep INVESTING Simple and Safe (KISS) ****Investment Philosophy, Strategy and various Valuation Methods**** The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!****Warren Buffett: Rule No. 1 - Never lose money. Rule No. 2 - Never forget Rule No. 1.
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