Home Wealth Investment When is a corporate blow-up a buy?

When is a corporate blow-up a buy?

How to tell disaster from opportunity.

Azal Khan

Digital Journalist, Your Money

Editor’s note: This article contains information only. It is not intended as personal or general advice. Your Money recommends seeking professional advice specific to your personal circumstances.


For the well-informed investor, corporate troubles can be seen as an opportunity to buy a company’s shares at a fraction of the price.

The win occurs when the share price eventually goes up.

But does trouble in paradise always spell an opportunity for investors?

Market analyst Claude Walker from Simply Wall Street says there’s little upside to investing in a company during turbulent times – with some exceptions.

Shares in billion-dollar commercial airline manufacturer Boeing plummeted this week after the tragic crash of an Ethiopian Airlines plane that killed all 157 people on board. The aircraft was a Boeing 737 Max 8 which has been involved in two deadly incidents in the past six months.

Read: Boeing disaster reaches Australian shores 

The air disaster prompted airlines around the world to ground their Max 8 fleet.

The fall in Boeing shares has made the stock’s valuation less expensive but that doesn’t mean investors should scramble to buy up stocks.

“Those people have strong guts because they are basically betting that despite the loss of many lives, the company will come through unscathed,” Walker said.

“What airline in their right mind would be buying this aircraft now?”

While Boeing may not be a good example of investing in a company in crisis, that’s not to say it’s a bad investment strategy.

There are examples of value investors who have waded into a cheap stock that has eventually “come good.”

“We saw a lot of that in the GFC because there was a lot of panic selling going on.”

As a general rule, however, Walker says investing in cheap stocks when a company is in turbulence is not a good “long term play”.

The best returns are usually seen when investors take a long term growth approach.

Investing in a company needs to be for the right reasons, which should be centred on the integrity of the business and whether it will deliver good value for customers and shareholders for years to come.

“If that was your view of Boeing and you think it’s a great business that is going to keep on doing a wonderful job for years to come, now might be your opportunity.”

“But if you’re just buying because people have overreacted, that’s not a strategy I see as paying off over a long term for many people,” Walker said.

What not to do

This investment strategy can sometimes be a trap, Walker said.

The strategy of buying cheap stocks when a company is in turmoil might be reasonable for a professional who can spend hours researching, Walker said.

“But for retail investors who don’t have that informational advantage, I think that is definitely how you could lose a lot of money,” he said.

The incredible downfall of Freedom Insurance group is one example of “what you should no do”.

The embattled life insurance company sold funeral insurance through a business model of directly selling insurance through call centres.

Read: Disabled victim’s father makes emotional plea to royal commission

It came under intense scrutiny at the banking royal commission, after which it became clear the company would have to pay back money from policies that shouldn’t have been sold in the first place.

The stock price dropped from 40 cents to 10 cents, then down to 2 cents until the shares were suspended, Walker explained.

“The royal commission exposed that they were selling very low-value insurance at very high prices to people who are often quite vulnerable, include almost pushing a Down Syndrome fellow into buying, then not making it easy for him to quit once he realised that he’s signed up to something he didn’t want or need.”

“This was a very obvious sign of rot within the company,” he said.

Does the strategy work at all?

“I think that’s the question to ask: does this bit of bad news change the long term quality of the company and what people are going to think of their product?”

“If not, it could be an opportunity.”

Walker said one of the best examples of this situation was in 2011 with stocks of medical device company Cochlear.

The company recalled a malfunctioning product which caused the share price to slide from around $70 to the $40 range.

“Turns out it was possible the most sweetest time you could possibly buy,” Walker said.

While it was a set back for the company, the fact that it is a “quality company that was making a product that was helping people” didn’t change.

“I can see why people worry. It’s not a good look and it’s bad for the brand.

“But ultimately it didn’t change that quality story,” Walker said.

Read more: What to do when your shares take a plunge
More: Can you make money by investing ethically?
More: $75 billion fund manager reveals investment outlook

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