CRITERION: Thinking of risking a finger on a falling knife? Sometimes they come back…
The ‘catch a falling knife’ gambit – buying beaten-down shares – stands to be tested after a series of savage sell downs involving some of our biggest listed companies.
In late January, Domino’s Pizza Enterprise (ASX:DMP) stock plunged 30 per cent in one day after an earnings downgrade – only two months after delivered an upbeat trading update.
Other plunging stocks include NDIS and employment intermediary APM Human Services (ASX:APM), sterilisation device play Nanosonics (ASX:NAN), A.I. mob Appen (ASX:APX) and student wrangler IDP Education (ASX:IEL).
APM and Nanosonics had disappointing earnings/sales updates, while Appen lost Google as a client. The IDP Education sell off appears to stem from Canada’s decision to limit foreign student visas, but the stock has been off the pace for the past year.
While there’s no firm rule, the shares of established, profitable entities tend to recover – and sometimes quickly.
Factors include whether the problem reflects a cyclical downturn (as with lithium), or whether a self-inflicted problem can be corrected.
Domino’s for instance blamed the profit warning on poor sales in Japan, but the local franchise is fine. Presumably the Japanese operation can be fixed with some tough love at the end of a sharpened Samurai sword.
Last October, shares in debt collector Credit Corp (ASX:CCP) fell 44 per cent on the back of a bleak trading update. The stock has more than recovered its losses.
Domino’s has a history of sharp retractions and then quick recoveries. That said, the stock is trading at one-quarter of its peak level of $160 in September 2021.
Similarly, Nanosonics shares have a habit of falling sharply and recovering, although at around $3 a share the stock is well below its zenith of $7.80 in December 2020.
It’s trickier when the self-off is spurred by something structural, as is the case with Appen and the loss of Google as a client.
Given the tech giant accounted for 30 per cent of Appen’s revenues and 25 per cent of profits, there’s no easy fix. But hopefully the new CEO – installed this week – will have answers beyond consulting Chatbot.
So how do investors protect themselves from being lacerated by the falling knife?
It goes without saying – but we’ll say it anyway – the company needs a balance sheet that is strong enough to avoid the bankers from calling the shots.
Another consideration is the extent is the level of short selling in the stock (short sellers sell a share before they have bought it, in the hope of purchasing it at a lower price to fulfil the transaction).
But a high level of shorting is not necessarily a ‘sell’ signal. On the contrary, if the company performs better than expected and the shares rise, the ‘shorters’ will scramble to buy shares to cover their position (thus pushing up the price further).
On January 29, shares in the marked-down tech play Megaport (ASX:MP1) soared 28 per cent after a better than expected update, to $12.48.
The current short position in the company is around 2.4 per cent, compared with 12 per cent when the stock slumped to a low of $4.30 in April 2023.
Buyers of trashed shares have the comfort of knowing they are not buying at the peak. But there are disconcerting exceptions to the rule, as holders in the collapsed health/wellness plays BWX (ASX:BWX), Bod Health Science (ASX:BOD) and Halo Food (ASX:HLF) would attest.
This story does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.
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