In last week’s article I took a look at the temptation offered by the UK’s Falling Stars – former high flyers that have fallen out of favour.
Many of these stocks have quality reputations and long-lived business models that seem to offer the promise of value and future growth.
While some may never recapture their former glory, I think it’s fair to assume that some of these will recover.
Investing in these turnarounds at an early stage can be lucrative. As a follow up to last week’s piece, I’ve decided to spend some time taking a closer look at how I’d approach this kind of analysis using FTSE 100 drinks giant Diageo (LON:DGE) as a case study.
Wealth warning! What follows is very much a discussion of a subjective stock-picking approach that requires careful research.
I would not suggest buying Falling Stars as a systematic investing strategy. Indeed, I think we should be very cautious about buying such stocks.
There’s always a very real risk that weak earnings and share price de-ratings can lead to longer periods of underperformance than anyone expects. In addition, there are some Falling Stars that simply won’t make a full recovery.
Famed UK investor Jim Slater had some pithy words on this subject in his book The Zulu Principle:
If someone throws a safe out of a window from the penthouse of a skyscraper, you will be severely damaged if you lean out of a window on the third floor and try to catch it.
It’s often far safer and potentially more profitable to wait for concrete evidence of a turnaround before considering an investment. For Slater, this was an inviolable rule:
It is absolutely essential that the forecast for the year ahead shows rising profits or a return to profits.
You are looking for the first glimmer of a change – the first hint of good news after the gloom. You will pay a little more this way but look upon the extra cost as an insurance premium.
Case study: Diageo
The highest profile and perhaps most tempting candidate on the current list of Falling Stars is Diageo.
This £46bn company owns brands such as Guinness and Johnnie Walker. It featured heavily in the…
