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MARKET COMMENT
By
Never catch a falling knife.
You'll see this well-worn investment phrase all the time on our discussion boards. But is it good advice? The basic reasoning is simple. A share that is falling heavily is likely to be doing so for good reason. So investors should steer clear, at least until it stops falling. Sometimes there is an obvious reason for the fall, like BTG's (LSE: BGC) recent admission that its key product was facing delays. This led to its shares falling almost 60% in one day last month. Today, its shares have fallen back again, as the company revealed the delay could be as long as two years. At other times, share price falls appear to happen for no obvious reason. Deciding a course of action in these cases is far trickier. Do you wait for the company to confirm that nothing untoward is happening, or perhaps check on other companies in the sector to see if they are having difficulties? But regardless of the difficulties of individual investing decisions, what about the strategy as a whole? How do falling knives perform as a group? Contrary to the traditional investing wisdom, a recent study (pdf file) by The Brandes Institute has suggested catching falling knives can be worthwhile. They define a falling knife as a share that has fallen 60% or more in a twelve-month period and found that these shares tend to outperform their country's main index for the next two years. There are some caveats of course. The outperformance is mainly due to a small proportion of exceptional performers -- shares that double or more. WS Atkins (LSE: ATK) is a classic example. It topped our table of profit warnings for 2002. Yet, within twelve months, its shares had risen eight-fold. So picking the occasional falling knife is very much hit and miss. Unless luck is on your side, and you happen to select one of the big gainers, knife catching just isn't going to cut it. You need a selection of sickly shares to turn the odds in your favour. The researchers also found that sticking to larger companies and those with the lowest price to book ratio also improved your odds. Sounds a bit like value investing to me!