Two fatal crashes of Boeing 737 Max jets…a jury verdict that Monsanto’s weed killer causes cancer…the discovery of massive fraud at Volkswagen. These all are examples of disastrous events that can shake the confidence of not just consumers but also current and potential investors. As each company’s stock price drops, investors grapple with questions of whether to sell shares that they already own and/or, at some point, buy shares.
Bottom Line Personal asked corporate turnaround and investment expert Bruce W. Kaser, CFA, what he has learned in making such decisions and how that can help guide you in distinguishing companies whose stocks will rebound after a catastrophe from those that may never fully recover from a downward spiral.
A Three-Point Checklist
I have a three-point checklist for evaluating the stock of a company hit with a crisis. This is useful whether you already have the stock in your portfolio and are considering a sale or are thinking of buying shares after the price has fallen. In either case, if I don’t have a high degree of certainty on all three points, I sell the stock if I own it and/or refrain from purchasing shares. Here are the three guidelines and examples of why I chose not to invest in a company because it failed to meet the guidelines…
Decide whether the crisis is due to a product or service that is inherently unsafe, unfixable and/or could threaten the future of the company. I look for crises that are containable and have a clear solution—otherwise, it’s too risky to invest. Too risky: Agrochemical giant Monsanto faces mounting lawsuits from more than 11,000 plaintiffs claiming a cancer link to its weed killer Roundup, as well as three recent court awards to plaintiffs totaling more than $2.2 billion. I can’t figure out how many more lawsuits there may be or the company’s ultimate liability or whether the product will have to be discontinued. Since the first verdict in August 2018, shares of Bayer, the parent of Monsanto, have lost 44%.
Evaluate the company’s responsiveness. Does management acknowledge its accountability and convincingly take actions to correct the problems? Too weak a response: Wells Fargo & Co. had multiple scandals in which it defrauded its own customers. Although it attempted to rescue its reputation in a series of ads and switched CEOs (twice), management has repeatedly blamed rogue employees rather than convincingly address its flawed culture. The stock price is lower than when news of the first scandal broke in September 2016.
Make sure the troubled company’s stock sells at a valuation attractive enough to compensate for the uncertainty of owning it. Too expensive: The stock price of the pizza chain Papa John’s International has plunged in the past few years, partly due to racist comments by its former chairman. But shares still aren’t cheap enough, even with the leadership change and addition of basketball legend Shaquille O’Neal to the board of directors. They currently trade at only a small discount to shares of its better-run competitor Domino’s.
If You Already Own Shares
If you have already invested in a company before a crisis hits, review the checklist above. Stick with the stock only if you believe that the problems will be solved, that management can be trusted and that the valuation is attractive. If you don’t believe all three to be the case, sell your shares. If you’re not sure yet, set a predetermined limit of how much you can stand to lose before selling. That limit might be 10% for a mature, slow-growing company…or 20% for a fast-growing one with a stock that’s more volatile.
Crises I Considered Investing In
Here are four high-profile companies that experienced disastrous news and the process I went through that led me to invest in the stock of two of them and pass on the other two.
Thumbs down…
When customers die because of a company’s mistakes: The Boeing Company (BA). Within less than five months, two Boeing 737 Max jets crashed, killing all 346 people on the planes. It’s hard to know to what degree and how long it will take for the public and investors to regain faith in a company whose products are linked to death.
Why I didn’t invest in Boeing: First, the safety of a core product is being questioned. Investigations into the crashes suggest that Boeing used a decades-old design and skipped some safety features to save time and money, leading customers and airlines to wonder if these flaws render the 737 Max inherently unsafe. More than 350 Max jets have been grounded for months. Further, hundreds of billions of dollars of new Max orders may be canceled, threatening a highly profitable segment of Boeing’s business. Also, Boeing may face large legal liabilities. The company was slow to take responsibility for the problems, harming its reputation and delaying resolution of the problem. Finally, Boeing’s shares are expensive and only modestly off record highs, creating sizable downside risk.
When the crisis damages the reputation of the core business: Equifax (EFX), the credit-reporting company, suffered one of the largest cyberthefts in history in September 2017, affecting the accounts of more than 146 million people. Of course, hacking incidents often create opportunities for turnaround investments. For example, consumers whose credit card numbers were exposed by companies with lax security, such as The Home Depot and Marriott, felt angry. But in contrast to the Equifax situation, those breaches didn’t compromise the reputations of their actual businesses.
Why I didn’t invest in Equifax: Consumer data security is vital to the company’s core business. I felt Equifax’s future viability was undermined because its business depends on how it handles personal data. Consumers felt betrayed because the stolen data included Social Security and driver’s license numbers, potentially leading to identity fraud. Equifax didn’t report the cybertheft to consumers until six weeks after it was discovered, and it initially offered low-value free credit monitoring and only if victims waived their rights to sue Equifax. Its share price is down 15% since September 2017.
Thumbs up…
When a company does what an outraged public is demanding: SeaWorld Entertainment (SEAS), one of the largest US theme park operators, suffered a major drop in attendance after a 2013 documentary film exposed the exploitation of orcas (killer whales) in SeaWorld shows. Companies alienate investors during a crisis if they’re arrogant and oblivious to public opinion.
Why I invested in SeaWorld: I held off buying shares because SeaWorld attacked the film’s credibility rather than addressing its concerns. I invested three years ago when SeaWorld pledged to phase out orca shows and stop breeding orcas in captivity. Since its 2016 lows, SeaWorld stock has risen more than 160%.
When a company takes responsibility for an ethical lapse and convincingly changes its culture: Volkswagen (VWAGY), the German automaker, cheated on diesel-emissions tests in 2015 by installing software that gave fraudulent readings on nearly 600,000 diesel-engine vehicles sold in the US. But investors often forgive cheating if a company settles the charges by paying fines and agrees to far-reaching changes.
Why I invested: I bought shares in 2017 after the company paid $25 billion in fines and tapped a former BMW executive to be CEO. Unlike the unconvincing leadership changes that Wells Fargo made, Volkswagen removed top executives associated with Dieselgate, and the new CEO has set about overhauling Volkswagen’s insular environment. Since 2017, the stock has risen 10%.
