Beaten Down Stocks versus Reasonable Quality Stocks

27th Dec '16 by Dearg Doom

17 comments 14025 reads

FALLEN ANGELS

Investors can feel left out of the information loop given the length of time between RNS announcements. Our only clues are often the week to week share price movements. Only the company’s management and analysts know the true story.

I can sometimes be guilty of buying more shares or averaging down on poorly performing stocks. Normally, it is more out of boredom and often an unwillingness to face a past misjudgment on a share.

Given some of the worst stocks for the year included Crawshaws, Fairpoint, IG Group, and Sports Direct, is it wise now to invest or double down on existing investments? Will the worst performing stocks on balance this year outperform stocks with better prospects although on higher valuation?

Perhaps flawed thinking by other investors may have caused the maximum destruction of shareholder value to date already. These stocks may have hit a temporary low point in their respective companies’ share prices given the lack of RNS information. Is it wishful thinking that the shares having stopped falling and have become flat knives as distinct from falling knives where the share price is flat lining. Do they provide a safer investment point with a good reward/risk ratio? Of course, it may be that all the bad news is not already out.

Some of 2016 Worst Stocks

Some of the worst performing 2016 stocks included Crawshaw, Fairpoint, IG Group, and Sports Direct. Is it wise to invest at this stage or double down on existing investments? Will the worst performing stocks on balance this year outperform stocks with better prospects although on higher valuation?

Crawshaw (LON:CRAW) Share - Price 21.5p. I avoided this share at the top but as early knife catchers learnt, you can do just as much damage catching a butcher’s knife on the way down when you buy in size. I was tempted once again and double down at 22p recently. Obviously, I am hoping for a better outcome next year from Crawshaws on reduced expectations. Need 50% uplift in share price for a break-even.

Fairpoint Plc

Fairpoint (LON:FRP) 14.5p. No further market news since the recent trading update. Is the business model struggling given the size of outstanding loans? Fundraising on the cards perhaps! Some areas of its business are…

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imranawan

27th Dec '16

Dearg,

Interesting article. I'm interested in your thought process. For example you doubled down on Fairpoint (LON:FRP), a stock where as you say it would need to rise 300-500% for existing investors to break-even. Isn't this likely to result in shareholders offloading shares on any rise(s) and thereby creating a stock over-hang. Also as you say management credibility is in tatters, especially as they re-iterated their commitment to the dividend in the September webinar and than three months later trading had deteriorated so badly that the divi had been cut.

Regards,
Imran.

Dearg Doom

Hi Imranwan,

Yes, my Fairpoint selection is poor and it highlights the daily struggles that investors deal with on a regular basis. It is far easier in the mindset to buy a lowly rated share than to pay up and pay high multiples on popular stocks like Gear4Music.

Fairpoint plc share price in my defense appeared to have reached a tipping point as sellers looked exhuasted and buyers were mostly absent given the low daily turnover. It is also easier to buy a share that you already own as you know the history and sentiment attached to the share.

Two possibilities struck me that a fundraising has already been discussed with major shareholders and hence the institutions were restricted in dealing, Hence the low daily turnover or that buyers were going to outnumber sellers in the days ahead with any bad news already being discounted in the price.

Investing can be relatively boring. Investors generally need to have some small percentage of a portfolio for trading purposes to maintain a daily interest. As regards stock overhang, I suspect the fall in Fairpoint's share price happened so quickly, that a 100% increase in the share price is not enough for existing investors to head for the exits.

One scenario for the four stocks is for one to outperform, two stocks to be static relative to the market and one stock a complete disaster. The actual percentages will have to wait until 2017. I'm also prepared for the worst of outcomes, a total loss that makes up a small percentage of my portfolio.

Regards

Dearg Doom

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TangoDoc

28th Dec '16

I too continue to hold Fairpoint but have done so in good measure because of family contacts in the legal profession who offer me an insight into their world. I see no reason to think that the need for legal advice is about to lessen. On the contrary, Brexit will create all sorts of legal minefields.Much change is about to happen, all of which will demand legal supervision, be it for good or ill. I think of Jacob Rees-Mogg talking of cutting EU red tape in regard to employment law and health and safety. I imagine that EU nationals who wish to continue living here after Brexit and have yet to hear anything reassuring about their status will need help. It is still the case that we have a housing shortage coupled with so much uncertainty about the future direction we will take and no sign that more house building is actually happening. Soon enough that dam will rupture. I am waiting until I see Fairpoint show a believable recovery before I scoop up some more.

ls2g08

Hi Doom,

Good idea for a experiment, my only qualm is your sample size is way too small to draw any statistically significant conclusions.

Hi Is2g08,

Yes, I agree the sample size is way too small and the results are not statistically significant except to that individual investor. However, most investors have a limited universe of stocks they follow, regarding a small number of sectors and market caps size.

Each investor (if they choose) by doing their own mini-portfolio of fallen angels and aspiring angels can see what would have happened if they had gone with their own two opposite portfolios. It is relatively easy for each investor to do and not too time-consuming.

Each investor has a few dogs(shares) which should be disposed of in favour of better quality but higher price stocks. Stubbornness to hold underperforming shares persists in the face of much statistical evidence to the contrary. Feeling the financial effects personally will be a valuable lesson for me and maybe for other investors on correct pruning of portfolio by either disposing or doubling down.

Shares will have to be bought and sold as normally as events unfold. No point being a martyr for the entire year.

Thank you for your reply,

Dearg Doom

Rusty2

Why is Gattaca (LON:GATC) in the Aspiring Angels section should it not be a Fallen Angel?

Nick de Peyster

"I can sometimes be guilty of buying more shares or averaging down on poorly performing stocks. Normally, it is more out of boredom and often an unwillingness to face a past misjudgment on a share. " Has averaging down worked out for you in the past?

Nick de Peyster
http://undervaluedstocks.info/

Hi Herbie,

Yes, Gattaca could well have been put into the other portfolio. The swing factors for putting Gattaca into the Aspiring Angel portfolio was my own prior enthusiasm for buying the share. This was due to management positive outlook and the turnaround in earnings expected. Many wiser commentators considered Gattaca's low p/e very good value versus the rest of the market. The only negative for me is the declining recent share price action in Gattaca. Once bitten recently with Fairpoint, now twice shy about diving into any recovering aspiring angel.

Revolution Bars plc is the another good quality stock at a reasonable value that I could have put in the aspiring angel portfolio. However, I could not deny myself the opportunity to buy the stock. So it won't be a case of what might have been if other choices had been made.

Other portfolios that you and other readers may care to share in the same vein of thought with or without commentary very welcome.

Regards

Dearg Doom

AnonymousUser252054

Market Makers are like gods when it comes to pricing upon a profit warning. I can imagine a situation where not a single share in a company issuing bad news is actually sold but a 50% mark-down whacks the price into the long grass.

DVB99

29th Dec '16

about Photo-me, while it is on a highish rating ( PE about 18 i think), it has a dividend yield of over 4%, not much debt and generates cash.
In fact, PHTM generally generates enough cash to pay special dividends every 3-4 years!
They are rolling out new products, and also most of their earnings are outside of the UK, so for me it is still a hold

xcity

Fairpoint (LON:FRP).

Chris Moat is on his way out but will stay long enough to close the old Fairpoint business.

The newly executive chairman is a solicitor.
In the circumstances, I anticipate the possibility of kitchen sinking with the next set of figures; hopefully next - I'd hate to think that it will still be rumbling on after that.
But how good is their recently acquired legal business? Do Fairpoint have the capability to manage it? How is it better off being a quoted company with a busted balance sheet?
For me to have any interest in buying, I'd need positive answers to those questions. I don't see it staying as it is for long once all the gore has been swept away.

The falling share price was, in the absence of any news, suggesting that it was going badly wrong. I'm quite happy with falling knives, but not when they seem to be saying that someone, possibly inside, knows something I don't.

aflash

30th Dec '16

Since you agree your two categories are not statistically significant and other shares can be added or subtracted, I took two of yours and two of interest to me.
I also revised some of the notions in the Profit Survival Guide.

The first point is the question: 'What was your position at the time of the crash?' I remember from a previous post you bought IGG after the drop, as I did, and may now be showing a profit as I am.

Everyone appears to have been buying FRP on the way down so no-one has hope of showing a profit.
The second point is that IGG, PLUS and others did not warn on profits. The sector sold off because of the threat of regulation. Unlike FRP there is no company specific concern of poor management and integrity.

The third point regards trading and what you call the need for action to avoid boredom. Here it is important NOT to be holding when the drop occurs and try to buy at the lowest price possible.

Doubling down requires huge amounts of capital that could be deployed elsewhere. Nevertheless it does sometimes work in oversold conditions.

I took two of my own positions, CPI (Capita), a FTSE 100 stock and DVO (Devro), an old favourite who has over-expanded, and looked at what happened to each.

I jumped into CPI after the first warning because it is large cap and it just kept dropping. This was before the broadcast Profit Warning Webinar. I held back from DVO after the Profit Warning and the Webinar but it has bounced. I was not holding CPI but I was holding DVO. It turns out by buying more DVO on the day of the warning I would now be in profit.

There is no conclusion except Do Your Own Research & Develop Your Own Method. This is for my benefit to stop, look and listen. I do enjoy the challenge of trying to catch the lowest price of oversold stocks and shall continue. In the light of the Profit Warning Webinar, rather than assume I have a quality stock to hold, I shall sell on the bounce. PLUS has been and gone, IGG for 5 pounds anyone?

12th Apr '17

Crawshaw (LON:CRAW)

Bid/Offer 27p - 27.25p (up 10.4% today at time of writing)

Today's Volume currently 600,000+ Normal Market Size 7,500 shares

Tuesday 25th April, 2017 (Estimate)

Full Year 2016 Crawshaw Group PLC Earnings Release

Since March 22nd 2017, Crawshaws's share price has broken out twice with volume from a lowly share price of 15p. Some investors certainly do like the stock at the higher price. It would seem those new investors at least expect positive LFL sales and improved margins in the forthcoming trading statement. Whether that justifies the share price rise by 80%+ in three weeks is another matter.

Existing suffering shareholders will in the meantime have to guess whether the company is back on track having sorted out what went wrong previously or is there some other game-changing corporate action afoot?

My natural instinct is to sell some shares into this strength. Slicing more than half my holdings seems about right. I can now take a more relaxed approach with the balance.

Regards

Disclosure (I'm long Crawshaws. Opinion only. No advice ever intended)

26th Apr '17

Bid/Offer 25p - 26p (Down 15.7% today)

I always thought that if an ordinary butcher can make a profit for himself and family, then a chain of butcher shops with twice the normal turnover of a typical butcher should do well. Shareholders could even look forward to enjoying increasing profits with future additional retail outlets.

An awful set of RNS releases this morning showed cash burn and a lack of a turnaround anytime soon The transformational partnership announcement is really open to question. I had just hoped prior to today that sales and margins were increasing and possibly a growth strategy might have been on the cards. Instead, we have a survival scenario of sorts that is face saving for management.

The Cheap Cut.

Like-for-like sales have improved from -13.0% in Q3 to -7.4% in Q4 further progressing to -4.5% in the first 10 weeks of the FY2018

· Statutory loss before tax of £1.4m (2016: loss before tax £0.3m)

· Cash balances of £2.1m at 29 January 2017 (£4.9m at 31 January 2016)

It would have been nice to have been a fly on the wall regarding negotiations with 2sisters. Here is their website link. http://www.2sfg.com/ . 2sisters have succeeded effectively in getting Crawshaw in their grasp at 15.2p per share. This is almost the lowest point the shares ever traded. Crawshaws' shareholders have surely been sliced and diced quite nicely by management by the issuing of shares for 29.9% share in the company and also 20% of the company shares in warrants at 40p

The lack of premium for the shares demonstrates Crawshaw's management weak bargaining position. Profitability was obviously not on the immediate horizon. Crawshaw's own management plans as originally envisaged were now pretty much on hold.

I consider the warrant price of 40p is a distraction for existing shareholders. The warrant price might as well be £1.00. 2sisters will have long acquired the balance of the company at a lower price than 15.2p per share in the distant future.

Management must have been peppering themselves before this deal. Without the deal the shares would have been below 10p. The future now is only better for the management. They have secured an extension to their employment contracts. The company seems burdened with their excessive administration costs. Their management skills have been ineffective in delivering value to shareholders.

The nice bright mornings make a 7:00 a.m. rise so much more agreeable. It allows one to digest company news more easily. After due consideration, selling the balance of my holding first thing this morning was the obvious decision. I expect the share price to trend lower over next few weeks as existing shareholders figure out the less rosy scenarios.

As usual shareholders were last to be kept informed. We now can guess that the recent share price rise was based on corporate action. This could have been announced to the market earlier.

Time to move on to the next share!

Disclosure (No current shareholding in Crawshaw plc)

Re: Warrants

Just to clarify that if Crawshaw's plc share price stays above 40p for five consecutive days between 12 months and 24 months after the initial investment, then the warrant holder can acquire another 20.1% of Crawshaw's shares at 15.2p per share. Effectively, Crawshaw will have effectively sold 50% of the company for 15.2p per share.

The Company will issue Invest Co 1 Limited warrants ("the "Warrants") to subscribe for a further 45,436,069 Ordinary Shares (being such number of new Ordinary Shares as would increase the aggregate holding of Ordinary Shares of the Investors on completion of the Initial Investment to such number of Ordinary Shares as equals 50 per cent. of the further enlarged issued Ordinary Shares).

The Warrants will be exercisable by Invest Co 1 Limited (i) once only and over all, and not some only, of the Warrants; (ii) at any time in the period between the first and second anniversaries of completion of the Initial Investment provided that the closing mid-market share price of the Ordinary Shares as traded on the AIM market of London Stock Exchange plc has been above 40p for at least five consecutive trading days immediately prior to the date of the notice of exercise of the Warrants; and (iii) at an exercise of 15.2p per Warrant.

Most disappointing terms for existing shareholders.

hayashi22

27th Apr '17

So why is the share price going up?.Surely the answer is in the terms of the warrants?
I'm not a holder but interested as the various permutations make this a puzzler.
Suspect Bopadra knows the savings he can bring about from the combination better than most.

tiswas

3rd Aug '17

Interesting that Sports Direct had a stock rank of 59 and rated Contrarian just 8 weeks ago on 3rd June.

Now it has a stock rank of 94 and is rated a Super Stock.

Can/should a share performing poorly over an extended period become a "Super Stock" in the course of 8 weeks? The re-rating seems purely based on some optimistic assumptions made by the directors as far as I can tell.

Beaten Down Stocks versus Reasonable Quality Stocks

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Dearg Doom

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