Good Stocks Get Bad News
Investors often overreact to bad news. When that happens, good companies hit by bad news become that most exquisite thing: a value play. Rule of thumb: When a solid business runs into a temporary mess, it’s likely a buy signal. Two cases in point: Target (TGT) and JP Morgan Chase (JPM).
Target was until recently the darling of retail. With the recent security breach, its stock price tumbled. During the holiday season, hackers stole credit card and other information on millions of the chain’s customers.
The stock skidded from $73 per share last summer to $55 in February and now has inched back to near $60. According to FactSet, current and forward price/earnings ratios show the stock trades below its historical discount to the retail industry.
But the company has long demonstrated strong growth and earnings – until the bad news wrecked its fourth quarter. In 2013, it returned a nice $2.5 billion to investors through dividends and stock buybacks. Management’s strong response to fixing its cyber-vulnerabilities recalls Johnson & Johnson (JNJ) and its comeback from the 1982 poisoned Tylenol disaster.
Today, JP Morgan, once considered the best run large U.S. bank, is suffering through its own brand crisis because of legal liabilities from past mortgage-related issues. Based on FactSet data, the stock trades at 9.25 forward earnings, well below the industry average of 11.19. On a price to book basis, the stock also trades below its historical range. It’s been in a trading band for the past year between $50 and $60 per share.
The company, however, is still the nation’s largest bank, and has huge reach. Yes, its underwriting and mortgage businesses flagged last year, coupled with an enormous $20 billion to resolve legal woes like its involvement with scam artist Bernard Madoff. Yet the economy and housing are picking up, which will play to JP Morgan’s strengths. The market has sensed this, and the stock has rallied. At a P/E of around 13, though, it remains relatively inexpensive.
Both JPMorgan and Target are not out of harm’s way yet. Besides, these one-time crisis induced selloffs, there are still some operational problems that they need to improve, particularly with Target’s Canadian operations. But the smart investor who can look through these issues may find a great company at a bargain price.
We’ve seen this pattern before. Consider what happened after two other strong companies, BP and Toyota, ran into trouble.
In early 2010, BP (BP), long considered one of the premier integrated oil conglomerates in the world, made a costly mistake. Their deep water Macondo oil field suffered the largest accidental marine oil spill in history. Its stricken Gulf of Mexico rig lost 11 lives. Millions of barrels of oil polluted the ocean and coastlines. It was a catastrophe.
Investors reacted swiftly. On April 16, four days before the spill, the stock traded at $60. By June 25, a little over two months later, the stock closed at $27. BP, with a market cap of more than $180 billion prior to the accident, lost more than $70 billion in market value. That was even though, at the time, damage estimates were in the $5 billion to $30 billion range.
Were investors overly punishing BP, a company with exceptional long track record, a stellar reputation and prudent management? At the time, 38 analysts covered the company, and only three had a sell rating, yet the Macondo overhang presented a real risk with an uncertain liability.
By yearend 2010, the stock traded at $44. Clearly investors were rewarded if they bought in June 2010. Today, with most of the damage behind them, BP offers a generous yield, healthy balance sheet and a business that generated over $23 billion in net income during 2013 to shareholders.
Toyota (TM), a company that built a reputation on quality and service over decades of careful brand management, lost a good portion of that reputation in late 2009: An accelerator problem created a crisis that affected the automaker’s image and the stock price. After a car collision in August 2009, Toyota recalled 3.8 million vehicles due to floor mats trapping accelerator pedals. In January 2010, it recalled millions more for a similar problem – this time, the same accelerator issues, but without floor mats.
Consumers and investors reacted quickly. Shortly after the crisis, in a brand survey, consumers positively disposed to the brand dropped by more than 20%. At the same time, those unfavorably disposed rose by a similar amount. But today, Toyota has recovered nicely and the stock price, at about $103, is almost 50% higher than its Jan. 29, 2010, close of $77.00.
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Jason Lilly, CFA, CFP, is co-manager of the Bright Rock Funds and director of portfolio management at Rockland Trust. Opinions expressed in this article are the sole opinions of Jason Lilly and not his employer, and do not represent a recommendation to buy or sell stocks.
His firm has a position in Target.
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