GuruFocus Premium Membership

Serving Intelligent Investors since 2004. Only 96 cents a day.

Free Trial

Free 7-day Trial
All Articles and Columns »

Best Companies Plus Bad News Equals Big Returns - How Buffett, Klarman and Burbank Make Money

November 12, 2013 | About:
A stock dives more than 15% in over a week. Should you buy?

In the market we constantly come across companies that are down over 15% either in a day or a week or sometimes over a month. Most of the time the ones that we notice are the prominent names.

Though it is not possible to make money betting on all companies facing bad news as most will have serious problems, the strategy here is to identify the ones where there is nothing wrong with the company but the investors, the analysts and the media are overreacting.

The strategy is to look at companies where the moat is intact, the management integrity and ethics are unquestionable, financials and balance sheet look good and the company is profitable, but the only problem is that it is faced with a one-time setback or a negative event that can be fixed.

Let us look at a few companies whose stock dropped significantly due to bad news and what happened afterwards.



1. McGraw Hill Financial Inc. (MHFI)
[/b]
[b] The News: The U.S. government slams S&P with a $5 billion fraud lawsuit. The government is seeking $5 billion in its civil lawsuit against Standard & Poor's, accusing the ratings service of defrauding investors, in one of the most ambitious cases yet from the Justice Department ever conduct tied to the financial crisis.

[/u] Stock Drop: Down 28% from $58 to $42 in the first week of February 2013. Currently the stock is at $71.



Question to Ask:
Is this a threat to the operation of the business? Is the moat broken? Is management defrauding investors?

Buy argument: The answer to the above question was a no. This was a lawsuit that could be settled.



Gurus Who Bought:
John Burbank.

Had one bought the stock at $42 the returns would be roughly 70%.

[u]2. JPMorgan Chase (JPM)


The News: The company announced on May 10, 2012, that it lost billions on a bad trade (whale trade?).

Stock Drop: Down 23% from $43 to $33 in the first two weeks of May 2012. Currently the stock is at $54.



Question to Ask
: Is this a threat to the operation of the business? Is the moat broken? Is management defrauding investors?



Buy Argument
: The answer to the above question was a no. This was a mistake by one employee that cost the bank in billions.



Gurus who were invested and held
: Warren Buffett.

Had one bought the stock at $33 the returns would be roughly 64%.

Here is what Buffett had to say about this in his October interview on CNBC.

"If a cop follows you for 500 miles, you're going to get a ticket." That's how Warren Buffett described the legal troubles facing JPMorgan Chase and its chairman-CEO, Jamie Dimon.

"You can't be active in a big business without making some mistakes, and sometimes they may be big ones," Buffett said in a "Squawk Box" interview. "Jamie will survive fine. He knows how to run a bank."

Buffett likened Dimon's leadership prowess to one of baseball's all-time greats. "You have look at the overall record. Babe Ruth hit 60 home runs that one year. I don't know how many times he struck out. I don't care."

Buffett's comment above confirms the point that management and business matter and the short-term event can be dealt with.

"Many of the forces that cause securities prices to depart from underlying value are temporary."

- Seth Klarman


3. British Petroleum (BP)

The News: BP's biggest problem occurred in 2010 with the oil spill in the Gulf of Mexico



Stock Drop:
Down 55% from $60 to $27 in 2 months from April 23 to Jun 23 2010. currently stock at $46.



Question to Ask:
Is this a threat to the operation of the business? Moat Broken? Management defrauding investors?



Buy Argument:
Answer to above questions was a no. This was a problem that was fixable.



Gurus Who Bought:
Seth Klarman.

Had one bought the stock at $27 the returns would be 70%

4. American Public Education Inc. (APEI)

The News: Mainstream media has publicized anecdotal accounts of students saddled with high debt, school certification problems, recruiting violations and many more examples of bad behavior. The financial world has been talking about hedge funds shorting for-profit education companies.



Stock Drop
: Down 55% from $45 to $29 in a week (July 30 - Aug. 6, 2010). It is currently at $42.



Question to Ask
: Is this a threat to the operation of the business? Is the moat broken? Is management defrauding investors?



Buy Argument
: Answer to above questions was a no. This problem could be fixed by better controls.



Gurus who invested and added
: Jim Simons.

Had one bought the stock at $29 the returns would be 45%

“Price is a liar.” - John Burbank.

5. Baidu Inc. (BIDU)

The News: A poorly received quarterly report didn't help, and concerns about Qihoo 360 (QIHU) gaining ground since rolling out its own search platform last summer continue to linger.



Stock Drop
: Down 16% from $112 to $94 in a month from Jan. 11 to Feb.15, 2013. Currently the stock is at $155.



Question to Ask
: Is this a threat to the operation of the business? Moat Broken? Management defrauding investors?



Buy Argument
: The answer to the above questions was a no. Fear of a new competitor was an overreaction.



Gurus Who Invested
: John Burbank.

Had one bought the stock at $94 the returns would be 65%.

If you see in all the above cases the companies continued to make profits and the management was working towards solving the temporary problem.

So the next time you come across a company whose stock is significantly down ask yourself these questions:

Is the moat broken?

Is the management integrity in question?

Is this a permanent problem that is too hard or cannot be fixed?

If the answer to all the above questions is a "no" then we may have found a opportunity to make big returns.

About the author:

Itzar Juna
A software Engineer in love with the wonderful world of investing.

Visit Itzar Juna's Website


Rating: 3.6/5 (34 votes)

Comments

AlbertaSunwapta
AlbertaSunwapta - 8 months ago
"The News: The company announced on May 10, 2012, that it lost billions on a bad trade (whale trade?). .. Stock Drop: Down 23% "

One simple thing I would do is to subtract the "cost" or impact of the bad news from the current cap. In these cases to look at the % share price hit and then compare it to the current price unfortunately then includes a substantial general market movement. (Hence collateral buying of these companies by indexes, ETFs etc.) Had the general market not moved upwards the gains may not have materialized to the same extent. Nonetheless, point taken, bad but not permanently damaging events can drive down share prices beyond a reasonable measure.

Actually, the same applies to even permanent damage.
itzarjuna
Itzarjuna premium member - 8 months ago
Agree with you, when the market is moving upwards it is always tough to know if it is because of the company or the general market, But if you know enough about the company and its managers you can quantify. Also it gets interesting when a good company gets a bad news in a bear market.. you will need to wait longer to see gains as the market will not help even when the management is working towards fixing the temporary issue.

Thanks for reading and for your feedback.

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK
Email Hide