VALUE INVESTING
Crisis Plays

By Stephen Bland (TMFPyad)
September 14, 2001

Perhaps an obvious choice of subject this week as far as value investing is concerned for reasons into which I do not need to go here.

My definition of a crisis play is a blue chip share unreasonably depressed by some sudden negative event, the immediate perceived effect on profits of which is far greater than the real effect anticipated by the crisis investor. The idea is that when a bit more calm returns, investors realise that the share has been oversold and drive the price back up to its more usual level, creating a nice short term profit for the player. Often a good yield can be obtained whilst waiting. As always with value style investing, patience is needed for the recovery as well as the guts to go in when it all looks pretty dire.

Be careful though, some readers have misunderstood a crisis play to mean a share that is going through a real bad patch in the hope of recovery. That is not a crisis play, that is a share going through a crisis. Not the same thing at all.  Remember that the last thing a crisis player wants is a real crisis. Perception is all here. In the stock market, illusion is reality.

A couple of historical examples might be an oil company whose shares experienced a temporary drop because of a tanker spill and all the adverse publicity generated. Ultimately though, the  event proved to be a mere itch on the butt of the company concerned and investors soon forgot about the incident and rerated the share back to around its pre spill level. Another example I recall a while back was a major UK bank hammered by some well publicised scandal involving losses on derivatives trading. Herd following reverse mugpunters dumped the shares yet the actual effect on profits was for that year only and was not that serious. The bank in fact had fine growth forecasts and a nice yield at the depressed price. The shares eventually recovered sharply within a year or so as investors realised they had overdone the selling.

In the current market then, as you might expect, one of the hardest hit sectors is insurance companies. Clearly with such a major disaster there will be some gigantic payouts to be made yet the effect of this is not shared out equally amongst the companies. But the knee jerk reaction of the markets is to cream them all at first creating potential opportunity. There may well be companies out there that have virtually no exposure at all, hit by indiscriminate dumping of anything smelling remotely of insurance. This is where deep crisis players must look. Similarly those that have some exposure may still be oversold.

Insurers are an obvious hunting ground, but look at banks that have fallen. This makes no sense at all and is good example of a potential crisis situation. Why would Lloyds (LSE: LLOY) as one example be a poorer quality share the day after all this than before? I cannot see any reason. If anything banks may profit from the presumably enormous rebuilding programme that will be commenced by the ever resourceful Americans whom, as I know them, will not permit this tragedy to alter their way of life.

You can in this way look around the market for such plays. Concentrate on the sectors worst hit and look in there for shares that will not be really affected much at all yet have been dragged down illogically by mere association. Make sure that there is good reason for them to recover to pre crisis levels by examining the usual fundamentals, forecasts and so on. Look for clues, perhaps on bulletin boards here and elsewhere to get a mugpunter view against which to bet. You know the kind of thing, "Armageddon artists", "This time it's different" duffers and so on. People who know no history and have no understanding of human nature. Enough of these telling you that for example insurers are dead is a great bull signal for a crisis player.

A valuable piece of pop psychology, but nonetheless very true in my experience, is that poor investors overweight recent events over earlier ones when making investment decisions. Nobody ever learns anything and human nature remains unchanged for millennia. Upon this fact can money be made by the astute. But it involves risk, even the most apparently obvious crisis play can go wrong. Do not go in for this unless you can face that.