When we invest in companies we do so with the view of making some sort of hopefully decent return on the capital we have risked. If we are absolutely honest with ourselves not all of our investment decisions result in success. In fact, I would feel that if the average investor actually analysed the individual success rate of each of their investment decisions over a few years, that there is likely to be a significant number of decisions that did not turn out anywhere near as originally planned.
Our investment in a stock may decline for a number of reasons; the overall market may be bearish, sentiment to a sector or individual stock may not be favourable or the company is not progressing as anticipated. Within the not as anticipated category, we have the dreaded profits warning that we see within an RNS at 7:00 am when a company tells us that profits are going to be less than the market/company had expected.
The warning may come in various flavours i.e. “profits for the year xxyy will be significantly/materially lower than previously indicated” or maybe a milder warning “profits will be at the lower end of analysts expectations”. Either way, it’s not going to bring immediate joy to the portfolio but it’s something all investors will experience. The key thing is in my view how do you deal with it; oh and by the way “head in the sand” is not a serious option in my book.
Personally, I have a natural scepticism of CEOs especially the ones of smaller companies as they often have a tendency to be over-optimistic and paint a brighter picture than actually exists at the time of the profits warning. If we are unlucky, then the initial profits warning may well not be the only one that that company issues; with small companies they can have a habit of coming in threes. My scepticism together with many years of character building whilst learning in the school of hard knocks moulded my approach to dealing with warnings.
My general stance with a profits warning is to simply sell at the earliest opportunity unless there is a compelling reason that suggests to me that things will really get better quickly and the warning is to a large extent outside of the companies control e.g. at the lower end of expectations due to unfavourable currency exchange; not a great worry in my view.
What I am actually trying to do when I sell into a profits warning is to simply reduce the risk of further loss of capital and hopefully retain that capital to invest in a stock that has better apparent potential. So let’s have a look at the six profits warnings my overall portfolio has suffered these past three years, note It’s actually 7 if I include yesterday’s warning from Portmeirion which I had sold by 10:00 am, but time will tell how that one pans out:
the % change on buy to sell is simply the profit or loss on that transaction.
the SR is the Stockopedia stock rank on the day of the RNS/profits warning
Overall taking a hit and selling as the closing price on the day of the warning would have resulted in an average loss of -21%: in practice as I tend to sell early after opening, the loss is usually appreciably less that the close of day % fall I show in the above table. Hanging on in hope for six months would have increased the % fall from the RNS warning day to an average of -49% and holding on for 12 months (or 9 in the case of GMS) increases the average fall to -61%.
My inclusion of the Stockopedia SR is in no way a criticism of that fine system but merely a demonstration of the fact that the above stocks would be seen as attractive at the time of the profits warning; we are not talking about dodgy stocks.
As with everything I write on this blog, it’s not advice just me sharing what I have learnt over the years and generally what works for me.
Edit: Missed one: I also owned TSTL which gave a profits warning on 24/02/2016. At the time TSTL had a SR of 81. I sold early in the day at 124p, the price on opening was 143.5p. The price had drifted by the end of the profits warning day to 109p, a 25% fall on the day. Today, TSTL is standing at 91.5p which is a 38% fall from the opening price on profits warning day; that is 5 months later. Overall a good investment for me in getting out early on the warning and I made a profit of 67%.
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