Bumps in the road: what to do when good businesses run into problems

As investors, we all understand that companies will sometimes miss profit forecasts or suffer problems delivering on growth plans. These can be uncomfortable and are sometimes more surprising than they should be.

However, our research suggests that it’s fairly straightforward to develop a consistent approach for handling such issues in our own portfolio.

What’s often far harder to handle are the kinds of problems that sometimes arise seemingly out of the blue. Recent weeks have seen a number of these.

The recent cyber attack at Marks and Spencer (LON:MKS) is an example, as are the Daily Mail allegations of animal cruelty at pork producer Cranswick (LON:CWK). The share price reaction has been relatively modest in both cases. But neither issue is definitively resolved yet.

Further up the risk spectrum, an apparent failure of risk management at small-cap financial Argentex and an unexpected outcome to a regulatory investigation at Jarvis Securities have both left investors nursing painful and probably irreversible losses.

These events have made me think more carefully about how to respond to such issues when they arise.

In this piece I want to highlight some of the pros and cons of different approaches, as I see them. I’ll also suggest a checklist of factors to consider when such issues arise.

What can go wrong?

We can’t predict the exact problems (or changes) that will strike companies in which we’re invested. But there’s very little that’s new under the sun. Most unexpected events will fall into one (or more) of the categories below.

• Significant regulatory issues (especially financial)

• Allegations of corruption, fraud or other wrongdoing by the company or its senior executives

• Major accounting irregularities

• Outsized acquisitions

• Major lawsuits

• Sudden strategy pivots triggered by external events

• Events that prevent a company from trading normally for an extended period of time (e.g. cyber attack, geopolitical events)

• Serious debt issues

Sometimes these problems look like bombshells from day one. Sometimes, they creep into investors’ awareness through carefully-worded RNS statements and footnote disclosures. They may escalate over time – in my experience, it’s surprising how often an apparently isolated issue becomes a cluster of problems.

In these situations, I’ve found there’s a tendency for investors to take a curiously disjointed view of the situation. I’ve certainly done this myself, too many times.

On the one hand, I might think:

This could be a serious problem. It could cost £xyz and take years to resolve…

But at the same time, I may say to myself:

XYZ plc is a well-established company with good market share. It can handle this issue and its core attractions are unchanged. The shares could be a bargain. I should hold on/keep buying* because the shares are too cheap at this level on a long-term view.

(*delete as appropriate)

I call this the long-term fallacy.

The problem is that it’s is a bit like saying that you don’t need to wear a raincoat when it rains, because eventually you’ll dry off. Technically that’s true. But it ignores the risk of extreme discomfort, ill health and impaired effectiveness in the meantime.

Likewise, dealing with big problems is likely to be a distraction and a drain on the resources of even the largest and most well-run companies.

Worse still, there’s always a risk they just won’t recover.

Long-term opportunity - or trap?

At the outset of problems, it’s often very difficult to know whether they are manageable issues or the start of a protracted decline.

Let’s consider a couple of case studies.

In May 2016, both of these companies were FTSE 250 members with a market cap of c.£2.3bn. Today, one of them is worth £3.1bn. The other is worth just £127m.

Frasers (LON:FRAS): when Frasers (or Sports Direct as it was then) hit problems in 2016, shareholders had several opportunities to get out before the stock hit rock bottom:

Investors who ignored headlines such as “A day at the Gulag…” (about Sports Direct’s Derby warehouse) and kept their faith in Mike Ashley’s talents as a retailer have since been rewarded:

However, they had to endure a six-year wait to break even, with no dividends or share price progress.

This all took place against a backdrop of widespread failures in the retail sector, during which Ashley’s seemingly scattergun approach to buying distressed assets made him look either visionary or reckless.

I think it’s fair to say that Fraser’s long-term prospects were unclear at the time problems surfaced in 2016.

John Wood (LON:WG.): Like Frasers, this oil and gas services group was founded in the 1980s by an ambitious businessman who saw opportunity in changing times. Ian Wood built his firm up as the North Sea boomed and floated on the London market in 2002.

Wood retired as chair in 2012, but new risks really started to become apparent in 2017, when the company carried out a £2.2bn all-share merger with rival Amec Foster Wheeler (itself a merged entity created in 2014).

This deal was intended to diversify and scale Wood’s business. In reality, I’d argue that AFW introduced strategic drift and some nasty legacy issues into what had previously been a fairly decent business.

As problems mounted and the timescale for the resolution of AFW issues lengthened, shareholders had plenty of opportunity to get out:

However, there were also seemingly good reasons to stay put. I can remember looking at the business and arguing that its core attractions remained largely intact.

The endgame may have begun when Wood started to attract takeover offers.

In April 2023, the company disclosed that it had rejected four proposals from private equity group Apollo, valuing Wood at £1.7bn.

In May 2024, the company received a further offer from Dubai-based peer Sidara for £1.4bn.

For bulls, these bids might have seemed like evidence the shares were worth holding onto.

Bears – distressed by high debt, weak trading and management’s seeming inability to resolve issues or negotiate an exit – no doubt saw the failure of these (declining) bids as a further reason to sell.

As it turned out, these rejected bids were certainly a reason to sell. In February this year, Wood’s chief financial officer stepped down after admitting that his professional qualifications had been “mis-stated”.

In March, the company disclosed a wide range of accounting issues.

On 14 April, Sidara made a further proposal at just 35p per share (about £240m) plus $450m of new liquidity. The board said they’d be minded to recommend this deal if Sidara made a firm offer. This took place less than a year after rejecting a £1.4bn offer from Sidara.

At the end of April, Wood shares were suspended after the company failed to file accounts on time.

Sidara has not yet made a firm offer and remains in discussions with Wood’s lenders over the terms of a deal. With the stock down by more than 95% since Wood Group acquired Amec Foster Wheeler, shareholders can do nothing but wait, locked into a situation that could still worsen.

Conclusions

Things could have been different. Mike Ashley’s retail empire could have suffered the same fate as that of his reputed friend, TopShop founder Phillip Green.

Equally, Wood Group might have managed to handle the problems resulting from the AFW deal. The enlarged group could have emerged as a new regional market leader in oil and gas services.

And this is really my point. When companies hit problems of the types I’ve highlighted in this piece, they may just be bumps in the road – as M&S CEO Stuart Machin describes his firm’s ongoing cyber attack.

On the other hand, they may not. What I’ve learned from my own experience is that it’s often very difficult to tell the difference until it’s too late.

As Ed concluded in his recent piece “Should you really buy and hold? …”, all stocks are speculative.

Statistically, only a handful of quality compounders justify long-term faith and patience through periodic difficulties.

In general, I’d argue that the simplest way to deal with serious problems is to trigger an exit and move on to an opportunity with a more favourable probabilistic profile. The StockRanks can be helpful with that.