Saving good companies from the wolves

23/10/2019

Most investors hate bad news, and nothing grabs business page headlines quite like a good profit warning or run-in with the regulator.

Momentum is a powerful force in driving the direction of stock prices – arguably more so nowadays than ever – and when confidence in a company is rattled, events can quickly snowball. Share prices can be sent into freefall by investors’ tendency to ‘herd’, following others by panic-selling when there is a whiff of trouble.

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It is not just short-sightedness by ordinary investors that can exacerbate companies’ troubles, but also short-selling by professional ones. By taking large bets against a company’s future, these speculators hope to profit from a falling share price. Too often, the odds can be stacked against companies that might find themselves on the ropes, but are fundamentally sound businesses that do not deserve to fail.

An injection of capital at the right time can help ensure their survival. Not only this, but participating in their recovery, if successful, can prove enormously rewarding for investors.

Providing a lifeline for potential

There are times when companies, sometimes once-great ones, are doomed to fail. Business models can be rendered irrelevant by innovation and debt mountains can become insurmountable. In those cases, good money should not be thrown after bad.

For stock pickers, it is vital to spot when a recovery is possible, or indeed probable. After all, most businesses will go through rough patches, however mighty they were or may become. Take Apple during the 1990s, for instance.

Yet short-term investor sentiment can push companies to the brink. Heavily-indebted firms can be locked out of debt markets and refused credit lines at times when they urgently need to raise money. Issuing new shares is often one of their last options.

For investors who can muster a long-term view and the resolve to invest against the grain, moments like this can present a window of opportunity to buy shares at a compelling price.

It is important to stress that investing when shares have fallen is no more a guarantee of success than investing when they have risen. Nonetheless, I believe the scales of risk versus prospective reward can be tipped towards the latter when a company has fallen out of favour with other investors.

Recovery prospects hinge on the people leading the company. Having an experienced team at the helm can make the difference between turning the ship around or steering it onto the rocks. Company management must also demonstrate that they have a clear strategy to generate profits and growth over the coming years – after all, it is the prospect of these that justifies the risks of investing. You have to be selective.

Making future success possible

There is undoubtedly a ‘feel good’ factor that comes with participating in successful recoveries. Stepping in with a long-term investment when companies need backing can not only secure their future but, crucially, also help protect thousands of jobs – and potentially create new ones. Ultimately, this has to be good news for the real economy.

Active investors can aspire to meaningfully contribute to a company’s turnaround – not just to benefit from it. If the wolves can be kept from the door, and companies are given the breathing space they need to execute a strategy for recovery, investors’ patience can be rewarded if they emerge successful.

The views expressed by the author should not be taken as a recommendation, advice or forecast.

The value of a fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.