Recovery position – Companies that have fallen heavily in value can go on to make big returns
Imagine a company has seen its share price drop to the extent it is now 90% from its all-time high – how might it then perform over the next five years? Clearly, because otherwise there would be little point in bothering with this article, the short answer is ‘better than you might expect’. Before we reach the long answer, however, we will immediately concede the following analysis has a flaw or two.
The most obvious one is that, if you buy a stock that has fallen 90%, it does not automatically mean you are getting in at the bottom. Clearly it could still fall further – or it could rally thousands of percent back upwards. so, yes, 90% is a fairly arbitrary measure but it is also a reasonable proxy for a business the market thinks has a serious problem – whether that has to do with solvency, structure or whatever.
So what we have done is to crunch the numbers for the period from 1998 to 2008 – that, of course, being the most recent date where we can know what happened over the next five years. one of the things to jump out from this analysis, The results of which are set out in the table below, is that a very small proportion – just 3% – of companies that fell 90% actually went on to go bankrupt in that time.
Source: CITI research, December 2013
A much larger proportion of companies did, however, end up seeing their share price falling even further over the subsequent five-year period – in other words, the 90% floor did not represent the share price trough. you can see from the table that about 18% of companies, having already fallen 90%, went on to see their share price more than halve again from that point while a similar number saw their share price go on to fall again by anything up to half.
Add in the 3% that went bankrupt and we can see that some two-fifths of all the companies whose share price fell 90% then, to whatever extent, saw it fall even further over the next five years. While that is a significant proportion, however, it does of course mean three-fifths of all companies whose share price fell 90% then went on to see it rise over the subsequent five years – some by huge margins.
In fact, as you can see from the table, 16% of businesses that fell 90% in value then went on to see their share price increase by more than 500% over the five years that followed. Furthermore, for the period under review, the average return over those five years from buying a company whose share price had fallen 90% was 250% – to be clear, a positive 250%.
As we said at the start, this analysis is not perfect and another issue is it is hugely difficult to exploit – not least because, in reality, only a limited number of companies fall 90% in value in the first place and, if you bought all of them, you would end up with an extraordinarily concentrated and extreme portfolio with far more risk and volatility than almost anyone could stomach.
Nevertheless, the underlying premise is entirely exploitable and that is, on average, you can make significant amounts of money from identifying and buying into businesses where despair has set in and their share prices have fallen a long way. Yes, you could – you almost certainly will – lose money by buying into a basket case or two along the way but that is why we include the proviso “on average”.
But the numbers are the numbers and, while you can only lose 100% of your money in one company on the downside, the upside of doing the analysis and having the courage to go against the flow of the market could be many hundreds of percent. Here on The Value Perspective, we believe this is the proof in the pudding for a genuine solvency-type recovery portfolio.
Fund Manager, Equity Value
I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.
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