Buy on Bad News: What About Volkswagen?

One adage that many investors follow is “buy on bad news.”  The theory is that most mainstream investors will be selling as a result of the bad news and that may push the stock down below its true value.  Then when the news begins to improve, the mainstream investors will rush back into the stock pushing its price back up.

For the past six weeks or so few companies have suffered from more negative headlines than German automaker Volkswagen AG, which had recently taken over the mantle as the world’s largest producer of cars.  On September 18, the U.S. Environmental Protection Agency accused the company of cheating on emissions tests for many of its diesel vehicles, and it has faced a barrage of negative news ever since.  The news quickly drove the stock (the U.S. ADR – more on the different VW stocks below) down from about 38 to a recent low of 23.  Earlier in the year the stock had traded as high as 52.

Over the years we have looked at a number of companies facing massively negative headlines, which were often accompanied by major product recalls and the potential for extensive litigation.  While we have found no fully reliable pattern, and our research has been more anecdotal than scientific, our sense is that in most cases the stock remains weak for several months after the headlines begin to subside, but then recovers nicely over the ensuing few years.

In addition to the negative headlines, VW stock has two other related forces that could push it down further over the next couple of months.  The first is tax loss selling (although it should be noted that Volkswagen’s stockholders reside in many different countries whose tax laws may be quite different from the U.S.).  The other, known as “portfolio window dressing,” is the tendency of many investment managers to sell losing positions, or companies subject to negative headlines, before the end of the year so that the embarrassing names don’t show up in their annual portfolio reports.  We will have more on both of these phenomena – and the opportunities they create – in next month’s issue, but for now it is sufficient to say that they are likely to keep downward pressure on Volkswagen stock at least through the end of the calendar year.

All of this leads us to the view that while you probably don’t want to rush into VW stock right now, it could be quite attractive in the months to come.  The company will undoubtedly have to pay significant fines to regulators, and its sales and reputation will be hurt for some time to come, but the company has a long history of producing good cars that people want to buy, and that is not likely to change.

For investors willing to make a contrarian bet on Volkswagen, there are several different stocks to choose from.  The company has two different stocks that trade in Germany with the symbols VOW and VOW3.  Although the VOW3 is called a “preferrence stock” it appears to be more like what we would consider a common stock with a slightly higher dividend than the VOW.  U.S investors may find it easier to trade the ADRs (American Depository Receipts) VLKAY (which is equal to 1/5 share of VOW) or VLKPY (equal to 1/5 share of VOW3).  All four of these stocks seem to track each other pretty closely, and they all appear to have sufficient trading liquidity for most investors.

Looking at Volkswagen got us thinking about other stocks that have suffered from negative headlines (and related liabilities) over the past few years.  Two of our recommended stocks, BPand General Motors, and two other stocks, Lumber Liquidatorsand SeaWorld, came to mind as good candidates for the “Buy on bad news” approach.

BP, one of the world’s largest integrated oil companies, suffered negative headlines for several years after the massive oil spill at its Macondo drilling rig in the Gulf of Mexico in April 2010.  The company has now settled most of the litigation resulting from the spill, and the stock was beginning to recover last year when global oil prices began to fall sharply.  While the stock price will be largely driven by oil prices, we think it has more upside potential than many of the other major oil stocks because of its years in the publicity doghouse.

General Motors once held the title of world’s largest auto maker, but lost it years ago.  After the company emerged from a widely publicized bankruptcy, it was hit by concerns about liability for an ignition switch problem that appears to have caused a number of deaths.  The bankruptcy proceedings probably shield GM from most lawsuits relating to the problem, but the negative publicity has hurt the stock.  Recent results have been quite strong, and we think the stock has substantial upside potential.

Lumber Liquidators, the largest hardwood flooring retailer in the U.S., has had its share of bad headlines this year, beginning with a 60 Minutesstory last March accusing the company of importing flooring from China that contained dangerous levels of formaldehyde.  More recently, the company pled guilty to importing wood from an environmentally-sensitive area in Mongolia.  The negative news has also caused several key departures from the executive suite.  All that said, Lumber Liquidators is still likely to have $1 billion in sales this year, and there is very little debt on the balance sheet.  We’d suggest waiting until the year-end selling is done and a new CEO is in place, but the stock is definitely worth a look.

SeaWorld’s troubles began several years ago when an animal trainer was tragically killed by a killer whale.  Then a 2013 documentary suggested that the marine animal park operator was mistreating its whales.  With a new CEO working to rebuild the company’s image, and revenues bottoming out, a profit and stock price rebound may not be far away.

 

Bad Headlines Lead to Good Stock Profits?

Company

Symbol

Recent Price

5-Year Range

Market Cap $Bil.

Dividend Yield

Volkswagen ADR

VLKAY

27.62

54.88 – 22.71

65.69

4.0%

Volkswagen Pfd. ADR

VLKPY

24.12

56.73 – 20.62

57.37

4.6

BP p.l.c.*

BP

35.74

53.48 – 29.35

109.12

6.7

General Motors*

GM

35.22

41.85 – 18.72

54.81

4.0

Lumber Liquidators

LL

13.93

119.98 – 11.62

0.38

0.0

SeaWorld Entertainment

SEAS

20.01

39.65 – 15.11

1.81

4.3

* Previous TL Recommendation          

 

Disclosure Note Accounts managed by an affiliate of the Publisher own General Motors securities.

 

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stock market advicex

 

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George notes, "We see additional upside for the stock in 2018 as management's efforts continue to bear fruit, though the gains will likely be more muted than we saw in 2017."