Our profit warnings coverage has recently hit 100 separate warnings recently, so perhaps this is a good time to reflect on current results so far. It is my belief that the market can irrationally price companies either way, for good or bad, so therefore all profit warnings are not equal. Some standard advice across the industry is that you should ditch your shares on a profit warning, but on the contrary it can be the case that the temporary low price seen at a profit warning is a terrific opportunity to buy.
My own trading strategy has changed in this regard, and my own estimation of intrinsic value is the guide of when to sell. In an ideal world, if you choose your shares well, you should not have to deal with profit warnings too often, but quite often business is not perfect and the unforeseen may happen. Out of my current portfolio I have suffered two warnings, (Somero and BP Marsh), which overall has seen me a little down overall than if I chose to sell out (BP Marsh recovered, Somero got worse). In both cases I chose not to sell out because the price I believe was not correct, although now my target prices will result in much less profit than anticipated (although these prices can be revised on further updates).
Before we begin some basic stats, let us recap some limitations of these insights:
- Not all profit warnings are covered. Some releases may be profit warnings but don’t reference this at all (for instance where estimated figures are given without any reference to expectations. With many news items to read every day it may be the case that some have slipped through the analysis altogether. This list is therefore not comprehensive.
- It is the case that often one profit warning can lead to another. Superdry or Thomas Cook are good examples. Only the first one will be covered, which prevents them from skewing the results. This reflects a personal preference never to add to a losing position.
- The lowest share price attained in the first hour is used for comparison. This is a little unrealistic to expect one to attain, so an additional average first hour figure is added as well.
Overall, performance was not too bad. Had you bought every single profit warning at the lowest price, you would be virtually at the same level: +0.25%. Buying at the average first hour price leaves you down at -6.67%. These figures do not contain trading costs or dividends, but assuming you were buying in a big enough size (at least £1,000 a share), the income from dividends would likely leave you only a few percent down.
In context with performance of the FTSE All-Share:
The FTSE All-Share declined from 4225 to 4029, or a 4.6% decrease. So in real terms corrected for dividends, there is no real outperformance, but no real underperformance either. This is assuming you bought into every single profit warning.
The biggest loss you can face when buying a share is 100%, or all your money you put into a share. The worst-case scenario is that the company ceases trading, upon which your shares become worthless. Another bad scenario is where shares are diluted to the extent they are worth nothing, or companies that perform so badly the share price continues falling upon which they are bought out, and the share price is way off the highs.
During the period there were 5 companies that were disasters for holders, and these shares are not tradable anymore:
Thomas Cook (-100%): A massive news item recently. Now insolvent. Large debts combined with a perfect storm of poor macro factors led to a cash crunch.
Bonmarche (-86%): A terrible year for this clothes retailer, with several profit warnings. Bad conditions in retail combined with a large store estate led this being sold off at a large discount.
Flybe (-95%): A lesson learned for me. Although there was a certain amount of good assets which could be sold in the business (landing slots and aircraft), if the cash situation gets bad there may not be enough time to realise them. The entire Flybe business was sold for 1p a share, and the directors voted the deal through, no doubt preserving some nice jobs in the reformed company.
Debenhams (-100%): A wipeout for holders, as Debenhams entered administration. A restructuring rendered the shares worthless. The problems had been coming for a while.
Albert Technologies (-20%): Delisted from the market, as there were no benefits left for a company this size.
As we may see, losses are uncapped, but potential profits are not, which can lead to a situation where we could have more losers than winners and still be in profit overall. A common out after a profit warning is a buyout, as the market cap decreases and hence acquisition price, although the buying company typically still has to pay a premium.
There were four companies that were bought out and their shares ceased trading:
Footasylum (+92%): Bought out by competitor/friends JD Sport at a very generous premium.
KCOM (+119%): Bought out by MEIF 6 Fibre.
WYG (+205%): This project management company was bought out at a massive premium.
FFI Holdings (+78%): A surprising acquisition, although a company which was relatively unique.
There appears to be little warning that pre-dates a takeover, or at least I have not discerned a pattern. As time passes, I would expect the number of acquisitions (and wipeouts) to increase.
There were other winners who were not taken over although only two have posted increases of greater than 100%: Ten Lifestyle (+292%) has produced a terrific return since warning on profits, and Frontier Smart Technologies (+122%) were these companies.
Overall, at this moment in time it does seem that profit warnings are nothing to be fearful of, and the good cancel out the bad. In the coming days we will analyse some other factors to see if there is an edge to be had.