How to Turn Bad News Into Great Profits With Value Investing
Pure and simple, it’s the most trusted mantra of the investing world: Buy low and sell high. But when it comes to buying low, how do investors find the best opportunities?
Sometimes Wall Street hands them to you on a silver platter.
That’s because the analysts and investors on the Street aren’t infallible when valuing a stock. They’re human just like the rest of us and therefore prone to emotional reactions. If a company releases news they find less than pleasing, these stock market influencers sometimes panic and sell off their shares, sending the stock price plummeting. But many times, these knee-jerk reactions are unwarranted. And that gives us prime opportunities to grab stocks at low, discount prices and collect a tidy profit when they rebound.
In this article, we’ll discuss some of the biggest factors that can make Wall Street “get it wrong” — causing stocks to fall well below their real values. (This investment strategy is known as value investing, and you can find a primer to it here.) We’ll also talk about a way you can harness the power of the internet to send these opportunities straight to your email inbox, as well as another trick using a simple search engine.
6 News Events That Can Cause Deep Discounts
A bad headline can send a company’s shares plunging before investors consider the whole story. Here are some of the news events that can cause Wall Street to overreact, creating value-investing opportunities along the way:
Earnings announcements. When a company releases its quarterly or full-year financial results, revenue or profit performance that is even slightly below expectations can trigger a selloff of its stock. But as investors digest and consider the details of the results, the stock price can rebound within weeks or even days.
For example, in February 2017, chichi grocery chain Whole Foods Market (WFM) released its first-quarter results. While earnings met Wall Street’s expectations, the company posted a decline in sales, as well as a lowered outlook for the entire fiscal year. And Wall Street flipped out.
Following the earnings announcement, Whole Foods’ stock fell by roughly 4% in a few hours. But then investors began reading further into the company’s statements and recognized that Whole Foods is beginning a strategic turnaround that could help boost sales and secure the grocery chain’s future. The stock recovered its losses and then some within a day. While Whole Foods’ investors still may have to look to the long term for really juicy profits, those who saw past Wall Street’s knee-jerk reaction had a chance to grab shares for less than an organic emu egg (yes, that’s a thing).
Litigation. The announcement of a significant lawsuit introduces unpredictability, and unpredictability increases risk, both financial and reputational. When risk suddenly increases beyond the level investors are comfortable with, they sell, thinking it’s better to be safe than sorry. But investors aren’t always right. The company might win the lawsuit and shares might rebound. Often, however, companies settle lawsuits out of court — and that can give their stocks a lift too.
Back in 2014, real estate search engine Zillow (ZG) was sued by Move.com and the National Association of Realtors for allegedly obtaining trade secrets. The suit had a bad effect on the company’s stock as investors fretted for two years about litigation costs.
But in June 2016, the companies reached a settlement by which Zillow agreed to pay only $130 million. Now, that might sound like a ton of money, but because it was far below the $2 billion in damages investors had been expecting — and because the darn suit was finally over! — Zillow’s shares shot up 9% in a day.
Whistleblowers. When an employee “blows the whistle” and reports that their company is engaging in illegal, fraudulent or unethical practices, this too increases potential risk until the details and outcome of the situation are known.
Back in June 2016, a former employee of tech firm Oracle (ORCL) filed a lawsuit in a federal court regarding the company’s accounting practices. The day after the filing, shares of Oracle tumbled by about 4%.
Oracle of course denied any wrongdoing, and concerns that the case would put downward pressure on the company’s stock were unfounded. Within three weeks, Oracle was trading higher than it had in the runup to the filing. And by the time the company settled with the whistleblower, in February 2017, its stock had begun its trajectory to a multiyear high. If you had gotten in back on that fateful day in June 2016, you would have seen gains of more than 11%.
Accounting irregularities. A company, its auditors or the Securities and Exchange Commission (SEC) may raise questions about reported financial results — meaning the financial analyses on which investors based their decisions may not be real. This is a huge deal to the investment community, which will shun the stock until the questions are answered. Answering the questions takes time, sometimes months, and all the while the stock is slipping.
But sometimes good news during an ongoing investigation can boost a stock anyway, making profits for investors who hopped in on the initial dip.
Back in May 2016, Chinese e-commerce giant Alibaba (BABA) revealed it was undergoing an accounting probe by the SEC. In one day, the company’s stock shed 7%. However, within a few short months, positive quarterly earnings had pushed Alibaba’s stock up by nearly 40%.
Regulatory actions. In some industries a regulatory decision may cause damage to the stock value of a company. A biotech company failing to get the next step of FDA approval for a drug under development, or an oil company failing to obtain the rights for a major drilling or pipeline project may hurt the stock price within minutes, before financial analysts even have time to recast their financial models to predict what the “right” share price now is.
For example, in April 2016, biotech company Sarepta Therapeutics (SRPT) got blasted by a less-than-flattering FDA assessment of its treatment for Duchenne muscular dystrophy. The company’s stock cratered by more than 40% in a single morning.
But then the regulators turned around and approved the drug in September 2016, and Sarepta’s stock automatically shot up by more than 500% from that April selloff. I’d bet the investors who had panicked felt sorry they had missed gains like those.
Significant PR events. Even if a company has done nothing wrong, news coverage of the company’s dealings can affect its stock price. Sometimes it could be a scandal involving a celebrity who happened to have endorsed the brand or perhaps a recall of product that was no fault of the company itself. Or it could be a change in company personnel.
A classic example is the day in 2009 when Steve Jobs announced he was taking a leave of absence from Apple (AAPL). The stock slid over 11%.
But we all know what has happened since. Apple has made fortunes to the tune of 1,000% for investors who got in on that fateful day.
How to Have Stock News Sent to Your Inbox
All of these news events — and more — can cause the stock prices of valuable companies to become deeply discounted. But with so much happening in the media on a daily basis, finding opportunities can seem like an overwhelming task.
I recommend selecting a few key phrases (such as the types of events listed above) and setting up Google Alerts. This way, you can have information delivered to your inbox in real time and quickly go check out the financials of the company that has made the headlines to determine if it deserves the discount.
(Note: Check out my article “How to Find Undervalued Stocks and Turn a Large Profit” to know what to look for when you scan a company’s financials.
How to Find Winners Among the Biggest Losers
Another trick for finding discounted stocks is to use Google Finance. Scroll down to “Trends” and then select “Price.” This will display the five biggest “Gainers” and the five biggest “Losers” at that moment (typically, these are stocks that have lost 15% to 25% in the day’s trading session). The “Losers” list is a great place to start your hunt for undervalued opportunities, since any stock losing as much as 15% in one day has a story associated with it.
Click on each of the five Losers to go to a stock summary page. On the right-hand side you’ll find a chronological feed of news stories. These can include various pundits’ takes on why the stock is crashing today. You’ll need to critically read these articles. The same herd mentality that leads to a selloff often causes financial writers to follow the pack too. Also look at the list of “Related Companies”; is the whole group of peer companies trending down, or have you really identified a special situation?
Before you commit your hard-earned money to any value-investing strategy, try a few “phantom” investments and see how they do in a few days and/or weeks. This will give you a better feel for when Wall Street is getting it right and when it’s a case of “much ado about nothing” — from which you can profit big time.