Bad news investor is a person who invests primarily in stocks of companies that are in news due to bad reasons.
Why will ‘this’ person do this? Because with bad news, comes bad (lower) share prices. So when effects of bad news are over, the bad news investor expects to make profits when share prices rebound.
But does it make sense?
Theoretically it does.
But does it always make sense?
No.
As I said, theoretically it sounds like a good idea to buy on bad news. Its equivalent of buying low to sell higher later. But in reality, it is not easy.
When everyone around you is selling the stock you want to buy, it takes guts to go out and buy it.
More importantly, you need to be sure as to why your reason of buying is more sound than the reasons of those who are selling. Agreed that people panic and overreact. But why is it that you are right and they aren’t?
You need to be honest about that with yourself. And its not easy.
Every now and then, many companies come on the radar because of one bad news or the other. The result of such bad news can range from nothing (when investors ignore the news) to catastrophic fall in share prices (when investors pay heed to the news and sell in herds).
So what should you do if you hear some bad news about the company whose stock you always wanted to buy?
You need to ask yourself whether the bad news is about a temporary problem or a permanent one?
Temporary or Permanent Bad News?
You need to be careful about whether you actually understand the how / what / why / etc. of the problem or not?
Have a look at the matrix below:
A bad news can be temporary or permanent in nature. And it can have a small or a large impact on the business.
A temporary problem might be due to some small mistake of the management, due to temporary disruption in raw material supply that has led to loss of revenues, etc.
Such bad news may or may not have a big impact on company’s business. And more importantly, the effect is temporary.
If this bad news pulls down the share price – and if you think the business is good in general and rightly valued (more so after the price fall), it is an opportunity for you as an investor. You should consider buying. Even if everyone else is selling.
Cyclical businesses are known to witness regular flows of good and bad news depending on the cycle of their businesses. If you have observed the steel or shipping sector, there are times when share prices of companies in these sectors fall by almost 70-80%. Well run companies recover when cycle turns. And those that aren’t well run (and may have unmanageable levels of debt) don’t – they instead find their place in graveyard of dead companies. Some investors understand such cycles well and are able to time them brilliantly to invest + sell at the right times. But its not for everyone and its tough. It can cause huge losses if you get the timing wrong.
Coming back to the temporariness of the ‘bad news’, if you really think (and you need to be right about it) that the problem is temporary and will go away sooner or later, bad news for the company can actually be a good news for you as an investor.
If you can muster the courage to go against the crowd and buy (fallen) shares of company in temporary trouble, eventually you will benefit when the problem is over. Share prices will recover and make you look like a smart investor!
But on the other side of the spectrum are are problems that are permanent in nature. A government ruling capping rates, a change in consumer preference, an un-compete(ble) competitor entering the space, technological change that makes the product obsolete, an adverse court ruling, etc. – these problems are difficult for companies to recover from. Many do recover by changing the business models, product portfolio, etc. But in may cases, these problems are existential in nature. They just cannot be solved. Like horse-driven carts found themselves in problem when fuel-driven cars came. We all know what happened later.
So identifying whether the problem is temporary or permanent is of utmost importance.
Is Bad News Reason Enough?
Management of the company (in bad news) is also important.
Some people know how to steer the ship in troubled waters. They have proven it in past. If they get in trouble again, chances are high they will know how to act prudently and solve the problem.
So if a well run company driven by a good management finds itself in big temporary problem, its time to buy big time.
Most often than not, you will benefit.
That was about the company and its management.
But its you that is at the center of your universe.
You are deciding to invest your money. So lets talk a little about you too.
You?
Investing in bad news is not easy. Psychologically as well as financially.
Company’s recovery might take time (it can be years).
But can you wait for so long?
Do you have the time to allow the company to recover?
Lets say that the problem is temporary (might be solved in 1-3 years). But the money you want to invest is needed after 1 year. Can you invest then?
The answer is no – You are financially unable to wait out the storm and bad news.
(It is another matter that one should not be in stocks if time horizon is less than 5 years.)
For example – Suppose shares of a company fall from Rs 100 to Rs 60 due to some bad news. You know the business is good, management is capable and trust-worthy and more importantly, the problem is temporary. And that problem might be solved in 2-3 years. Now you put your money in the stock at Rs 60. After a year, you need the money. But the stock is still hovering between Rs 50-60. You have no option but to sell. Company keeps fighting with the problem for few more years. And eventually, (as your rightly thought) the problem was solved as it was temporary in nature. The price of share recovers to Rs 100 in 2nd year. Infact, it moves up to Rs 300 in another 2 years.
So inspite of your judgment (of the nature of problem) being right, you couldn’t take the full benefit.
Why?
Because you were not ready financially to invest (due to your time horizon constraints).
This is the reason why bad news alone won’t help you much as a long term investor.
You also need to be capable enough to wait out the period after the bad news. And it can take long.
Every bad news is not a good news for long term investors
Now don’t think that bad news about every company is a good time to invest.
In many cases (like companies with newly identified permanent problems), it is a good time to exit.
There is a cockroach theory too that states that if there is (a) bad news emerging from a company, chances are high that more bad news will follow.
Why cockroach?
Because most often than not, you will never see a cockroach alone. There are always few hiding nearby if you see one alone. 🙂
Bad News Investing makes sense but is not for everybody
Investing when things are going wrong takes guts (and being financially prepared). Someone like Warren Buffett can do it. He can afford to be wrong big time too. For obvious reasons.
Infact, If I am allowed to paint most of Buffett’s popular investments with the same brush, I would say that he is a real bad news investor. He needs bad news before he decides to invest. 🙂
But investing on bad news requires you to be a little optimist about the future too.
Being a pessimist might make you sound intellectual. And as J Mill says,
“I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.”
But we cannot be full-time pessimists if we want to invest in stocks. Can we?
😉
We definitely cannot eliminate the risk of being wrong. But we cannot give up on investing in equities. It is (almost) necessary – indirectly if not directly.
So we need to be cautious.
Investing in bad news does make sense. But only in few cases if you are convinced that the problem is solvable and you have the time to see it getting solved.
So think about it.
You cannot get good news and good (low) price together. You need to remember god in good times and equities in bad times. 🙂