One way I?ve seen people invest is to find companies that have recently suffered significant stock price declines. The logic behind their strategy is analogous to a bouncing ball – what goes down must come up.
Unfortunately, the truth is more complicated than that. There are cases when a steep fall in a company?s share price is justifiable such that a rebound in the price might not happen at all.
So, how can we tell the difference between a legitimate opportunity and a vicious trap? Let?s take a look at three different companies to have a better idea.
A battered pair
One way I’ve seen people invest is to find companies that have recently suffered significant stock price declines. The logic behind their strategy is analogous to a bouncing ball – what goes down must come up.
Unfortunately, the truth is more complicated than that. There are cases when a steep fall in a company’s share price is justifiable such that a rebound in the price might not happen at all.
So, how can we tell the difference between a legitimate opportunity and a vicious trap? Let’s take a look at three different companies to have a better idea.
A battered pair
Both Silverlake Axis Ltd (SGX: 5CP) and Noble Group Limited (SGX: N21) have experienced a sharp decline in their stock prices this year, after negative reports about their business and accounting practices had surfaced on the internet (see here and here for the negative reports).
In the case of Silverlake Axis, the banking software provider has seen its shares fall by over 40% in price since April 2015. As for the commodities trader, Noble, its shares have sunk by more than half since the beginning of 2015.
Given the situation, the declines were likely due to investors losing confidence in them. Even though both firms had rejected the allegations thrown their way, the damage hasn’t been repaired.
When investing in turnarounds, a key thing to look out for is a catalyst, an event that might cause the prices of the shares to return to or even exceed where they were before.
I mentioned earlier that the decline in Silverlake and Noble’s share prices might be due to investors’ loss of confidence in them. So if we are looking at both firms as potential turnaround candidates, we have to ask how they can regain trust from the investing community.
Winning back investors’ faith will be important. This is because even if they are able to report great financial results, doubts about whether the figures can be trusted – as a result of the allegations seen in the negative reports – may still be lingering. And if investors cannot believe the numbers that the companies are posting, there is no reason for investors to feel comfortable investing in them again.
A rig catastrophe
From a peak of S$3.29 per share at the beginning of the year, shares in oil-rig builder, Sembcorp Marine Ltd (SGX: S51), have fallen by nearly a third to S$2.28, currently.
Unlike Silverlake and Noble, however, Sembcorp Marine’s price decline is highly likely linked to the recent collapse in oil prices. The fuel, which was priced at more than US$100 per barrel in 2014, had fallen to as low as US$45 earlier this year.
As Sembcorp Marine is in the business of building rigs to serve the oil & gas industry, it’s not unreasonable to think that investors are worried that low oil prices may affect the firm’s business performance going forward. Signs of strain can already be seen. In Sembcorp Marine’s recent earnings release for its fiscal third-quarter, revenue and profit were down significantly by 34% and 77%, respectively.
In Sembcorp Marine’s case, what catalysts should investors be looking at for a possible turnaround to occur? This might seem obvious but one might expect the company’s share price to recover only when the price of oil starts moving to, and stays at, a higher level. If the fuel is priced higher, it would likely lead to more capital expenditures in the oil and gas sector and that in turn may lead to more contracts for Sembcorp Marine to build stuff.
The above examples show us how we can look at possible turnaround situations. Instead of simply buying stocks that have fallen in price, we should also try to understand why prices have fallen and what needs to happen for a rebound to occur.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn’t own shares in any companies mentioned.