Bad news investor – a term rarely heard—is used for investors who primarily invest in stocks of companies that are in news due to bad reasons. Theoretically, it sounds like a good idea to buy on bad news. It’s equivalent of buying low to sell higher later. But in reality, it is not easy. So, there is no direct answer whether bad news is an opportunity to invest or to exit because it all depends on the kind of news.
Temporary bad news
You have to find out if the news is permanent or temporary. A bad news can be temporary or permanent in nature and it can have a small or a large impact on the business. Temporary bad news can be attributed to any small mistake of the management; a strike/disruption in production or in raw material supply, etc. In short, any temporary setback which may result in temporary loss of revenues to the company can be termed as bad news.
This will pull down the share prices and as an investor you need to decide whether you can consider buying at this level.You need to understand that the news has not affected the overall outlook of the company. The business still remains good and is fairly valued. If it meets this criteria, then even if everyone is selling you can start buying. If you understand that the news is temporary, then such bad news for the company can actually be good news for you as an investor.
Permanent bad news
What if the bad news is permanent in nature? A government ruling, technological change, adverse court ruling, shift in consumer preference can be bad news. Many companies change the business model but it takes time for change to get implemented. Many times it cannot be solved. That is when an investor should avoid investing in the company. So identifying whether the problem is temporary or permanent is of utmost importance. On that basis we can know whether to invest or exit.
Also investing in bad news is not easy, since when everyone is bearish and selling, it is psychologically hard to buy. Also a company’s recovery may take time and an investor may have to wait for a long time before reaping any reward. Many a time, when companies come up with newly identified permanent problems, it is best to exit. Take, for instance, the Kingfisher Group. When bad news started surfacing and the company started defaulting, the stock price got hammered but investors continued to buy its shares, thinking that it had bottomed out. But the news was permanent in nature and so a decision to exit from the company would have been best.
So, any bad news coming out of the company should be analysed to understand what and how much impact it will have on the company, the nature of the news, severity and its consequences. Only after that you can decide whether it is a buying opportunity or a time to exit. You need to be cautious. You cannot completely eliminate the risk of being wrong.
Investing in bad news does make sense. But only in a few cases if you are convinced that the problem is solvable and you have the time to see it getting solved.
The writer is director,