Tipping point – the fall after the rise


  • Business
  • Saturday, 28 Mar 2009

Favoured stocks can lose their lustre suddenly. What drives the selling and why is it tough to rebound?

THE stock market is nothing if not fickle. How many times have we seen investors developing, almost overnight, a distaste for what have turned out to be flavour-of-the-month stocks? One day a counter is the toast of the investing community, and the next, it is just toast.

And more often than not, once a stock is dumped, it is incredibly difficult to win back the love. Some never return to the investors’ radar screen.

Transmile Group Bhd was a high-flyer not too long ago, and just about every significant development at the company is followed by a string of “Buy” recommendations. At the height of its run as a blue chip, it hit RM14.40 in January 2007.

A few months later, the price fell off a cliff. Today, Transmile is a penny stock. The share has plummeted a jaw-dropping 96% from the peak, in a period when the Kuala Lumpur Composite Index (CI) shed 21%. A full rebound from the horrifying drop would be an astonishing feat, if not a small miracle.

It is way too soon to say KNM Group Bhd will not soar again, but right now, it is the most recent example of a stock market darling that has quite suddenly lost its lustre.

Buoyed by the surging crude oil prices and its aggressive expansion, KNM raced from about 70 sen (after adjustment for new share issues) at the start of 2007 to peak at RM2.44 a year later. Within months, shareholders began rushing for the exit. The stock is trading at about 40 sen these days.

That is an 84% fall from the crest, more than double the CI’s contraction in the same span.

Of course, such share price plunges are not merely the consequences of caprice. Sure, these meltdowns are driven by emotions – impatience, disappointment, disapproval, anxiety, panic – but there are always underlying causes, major or otherwise.

“The event (that triggers the selling) may not be very impactful to the business, but the sentiments amplify the reaction,” says Kurnia Insurans (M) Bhd chief investment officer Pankaj C. Kumar.

So, investors are known to respond exaggeratedly to bad news (or good news, for that matter). That does not mean they are wrong in deciding to dispose of their shares. “It’s always an issue of fundamentals. Generally, the market gets it right. There is a reason for a sell-down. It doesn’t happen spontaneously,” adds Pankaj.

When the line goes down

There are different factors behind the noticeable loss of interest in once well-liked stocks. These are companies that have managed to at least make analysts and fund managers look their way, and have thus cultivated a following – albeit temporary – among investors.

(These stocks should not be confused with those gyrating counters that reek suspiciously of market manipulation and that are plainly short on solid business prospects. With syndicate-linked stocks, there can only be one explanation for a sharp decline – the puppet masters have decided to cut the strings.)

The catalysts for sell-downs are myriad: surprisingly poor results, mismanagement, bad deals, business models exposed as flawed, changes in government policies, the inability to adapt to the shifting industry and economic landscape, weakened political connections, shareholder tussles and corporate governance issues, among others.

What is perhaps more fascinating about the descent of favoured stocks is that there is usually a “tipping point”.

This is a term that author Malcolm Gladwell has borrowed from medical science. “It’s the name given to that moment in an epidemic when a virus reaches critical mass. It’s the boiling point. It’s the moment on the graph when the line starts to shoot straight upwards,” he explains in the gladwell.com website.

In the case of a fallen stock, the tipping point is when the price slide begins, and this is tied to the time when word of a negative happening at the company starts getting around.

This may emerge as market talk and is soon confirmed by the company through announcements and statements, or it may linger persistently as a rumour until the other shoe drops.

At times, the tipping point is painfully obvious, such as in Transmile’s case. The accounting scandal at the air cargo carrier is well-documented. The alarm bells went off when the company committed a no-no – it missed its April 2007 deadline for the submission of its audited 2006 accounts.

This was followed by a special audit, which uncovered large accounting discrepancies. Key executives were charged in court in relation to a misleading statement in the company’s quarterly report. Most importantly, analysts and investors were no longer sure what they knew about Transmile’s business.

Given such circumstances, even the presence of the Kuok group and Pos Malaysia Bhd as the largest shareholders was not enough to attract investors in the way Transmile used to.

Cutting both ways

The selling pressure on KNM shares, which began early last year, is harder to explain definitively. There are several theories floating around, and each seems plausible. It may well be a cocktail of factors that has induced the hangover.

One contention is that the oil and gas player has bitten off more than it can chew with its purchase of Germany-based Borsig. Then, there is the worry that amid the softening energy prices, KNM will have difficulty securing new jobs to utilise its much enlarged production capacity.

In addition, observers believe that the free fall was hastened by the banks’ forced selling of pledged KNM shares and by foreign funds liquidating their holdings because the cash was needed back home.

The last two elements illustrate the point that when a stock experiences a meltdown, the mentality and behaviour that propel the selling are as powerful as the basic reasons for the selling; it is not just about why people are letting go of the stock, but also the fact that people are indeed more than eager to do so.

A sell-down often takes a spiral course. When the share price dives, many shareholders are compelled to sell, further depressing the price. And on it goes.

It gets worse when investors borrow to buy shares. When the market value of the shares drops drastically, the banks or brokers will seek to limit their exposure by making margin calls. If the investors fail to pay up, the assets will be sold, typically at way below the purchase prices.

“There’ll be a run on the stock when there’s a forced sale of pledged shares. It will all fall like a house of cards,” says Datuk Kour Nam Ngum.

He went through exactly this when he was CEO of poultry company Comsa Farms Bhd back in 2006. When the stock was in the doldrums, a bank sold his pledged shares. That played a part in pushing Comsa to the brink. It failed to extricate itself from PN17 status and was delisted in April 2007.

Popularity with institutional investors is a double-edged sword. It is a great boost when things are going swimmingly, but when the outlook is shaky, the funds are likely to sell first and ask questions later, thus prolonging the sell-down.

Says a seasoned market observer: “It’s what they do. For fund managers, there’s nothing worse than the idea of being stuck with a stock that’s going downhill fast.”

Promises, promises

A stock meltdown is essentially the market’s way of expressing unhappiness over the company’s performance and direction.

The thing about shares whose prices incorporate generous premiums because analysts and investors anticipate good results and returns, is that the aftermath of failed promises can be ugly. The more believers the company has within the investing community, the more brutal the backlash when it does not deliver.

In many cases, companies that go through the tipping points are those that actively woo investors. The risk here is that of promising too much.

Malaysian Investor Relations Association (MIRA) CEO Eddie Razak points out that because Bursa Malaysia’s listing requirements forbid a company from promising something for the future, there should not be any overpromising.

“However, if the company has made some kind of representation or has given a certain perception, and if the reality turns out differently, then rightly so, the company must manage perception,” he adds.

Nevertheless, he rejects the notion that sell-downs happen because the companies’ management has failed to manage expectations. He says: “Stocks get sold down based on prospects. (But) if the management manages expectations, it will help cushion the blow.

Eddie argues that the market’s habit of penalising companies that do not perform to expectations is why many of them prefer to “shut up”. “Malaysian companies are apprehensive about doing investor relations as they get the sense that the market tends to be slow in recognising their efforts but quick to punish them,” he says.

Then again, that depends on how companies engage with the investing community and other stakeholders.

To Kossan Rubber Industries Bhd group corporate affairs senior manager Edward Yip, the key is to educate and not to oversell or whitewash.

“When you are communicating to investors the plus points of your company, it’s important to also tell them about the embedded risks. Whatever projections you make, be conservative. You shouldn’t be overly optimistic. That way, it’s easier to manage expectations than if you’re gung-ho,” he explains.

“You have to make sure the investors understand the industry and the business model. Frequent updates are important. And if analysts are too bullish with their projections, the companies should make it a point to correct them.”

Will they scale the heights again?

When stocks takes a traumatic tumble, the climb back to the top is always a huge challenge. CEOs are fond of saying the share prices do not always reflect the companies’ true worth, but in fact, a share price plunge inevitably does have a bearing on the performance of the businesses.

For one thing, when a company is seen as being in trouble, it is not just the investors who will be wringing their hands. Other stakeholders, such as employees, lenders, suppliers, customers and business partners, may be concerned as well.

Kour of Comsa Farms aims his criticism at the financial institutions, pointing out that their actions are instrumental in the success or failure of a business. “Banks have a habit of suddenly withdrawing credit lines. In livestock farming, that may mean the animals will have to go without food,” he says.

And when demoralised employees and jittery business associates lose faith and abandon ship, it is near impossible for the company to convince others that all is well.

Terence Wong, head of research at CIMB Research, reckons that the companies that do not recover from sell-downs are those that lack fundamentals in the first place.

“Look at Gamuda Bhd. Its share price has plunged a few times and it has recovered each time. It’s because it has the fundamentals. As long as you have the fundamentals, people will give you a second chance,” he says.

Pankaj of Kurnia Insurans, however, believes that it can be hard even for top-notch companies to regain investors’ confidence, especially in the currently tough economic and financial environment.

“At times like these, you worry about a company’s ability to service debts. And when it has too much cash, you worry that it will make bad acquisitions,” he laments.

Some companies make the mistake of keeping silent in the hope that the selling pressure will ease on its own. That may be a mistake.

MIRA’s Eddie says if the companies are putting in place mitigating steps and expect a recovery, they should present that information to the investors. “If the management has a recovery plan or the long-term industry prospects are good, the management must explain it,” he advises.

“Otherwise, the shares will continue to take a hammering for the wrong reasons.”

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