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Why On Earth Would You Invest In Afren Plc And Quindell PLC?

Retail investors are suckers for shares that have fallen heavily. The lure of a potential “multi-bagger” in double-quick time seems to bring up the pound signs in people’s eyes. “If this bounces back, I’ll have hit the jackpot!” is the cry.

It doesn’t seem to matter how distressed the business is. Even in cases where directors explicitly state that the company’s equity is likely to be worthless, you’ll still find buyers who are convinced the situation will somehow be turned around, and that the shares will rocket.

Oil company Afren (LSE: AFR) and insurance outsourcer Quindell (LSE: QPP) are two companies that have attracted hordes of get-rich-quick speculators, following the breathtaking crash of their shares. Afren’s shares are currently trading at 10.5p — 94% down from last year’s high, while Quindell’s shares are changing hands at 87p — down 87%.

Afren and Quindell — the former in danger of being crushed by a mountain of debt, and the latter embroiled in “cooking-the-books” allegations and an external review of its accounting policies — are more or less typical of the kind of companies and situations to which rapacious risk-takers flock.

Afren rejected a takeover approach 10 days ago because the offer was “significantly below the aggregate value of the debt”. The company now faces immediate liquidity and funding needs, and a recapitalisation that could dilute existing shareholders to smithereens. The company’s joint house broker, Merrill Lynch, is completely in the dark about prospects for shareholders: “We have been unable to get clarity on several key issues needed to fairly value the equity”.

Quindell is, similarly, a black hole of uncertainty. The company’s joint house broker, Canaccord, resigned in November and raised concerns about Quindell’s cash flow, accruals policy and goodwill impairment tests, among other things. Quindell’s Q4 cash flow came in miles below the Board’s guidance, leaving the company reliant on overdrafts from its banks. At the behest of the banks, auditor PwC is currently conducting an independent review (due to be completed by the end of this month) of “inter alia, the Group’s main accounting policies and expectations as to cash generation into 2015”.

Inability to service debts and the unravelling of “aggressive accounting” can often lead to companies collapsing and wiping out shareholders.

Investors currently punting on Afren and Quindell are keen to point to the odd case of, for example, a heavily over-indebted company defying the odds and coming back from the brink. “Look at Thomas Cook, they say: “12p in 2012 and a 10-bagger today”. Of course, selectivity glosses over the many train wrecks for every Thomas Cook!

As it happens, a few months before Thomas Cook hit that 12p low, I wrote about seven companies that I thought could go to the wall. Investors in Luminar, JJB Sports, Blacks Leisure, HMV, Clinton Cards and Game suffered 100% losses. Thomas Cook was the only survivor. Those who punted the tour operator did well; those who gambled on one of the other six didn’t.

If you can’t resist the lure of making high-risk bets on companies such as Afren and Quindell, you can at least guard against the risk of having to hit the food bank if you don’t hit the jackpot.

The crucial thing to that end is to use only a small proportion of your wealth to punt on casino stocks. I’m horrified when I read on financial bulletin boards that someone has invested their entire capital in just one of these high-risk shares; or, worse still, that they’ve leveraged their bet. That way lies madness.

Finally, it's worth remembering that less risky strategies may actually give better rewards in the long run. In fact, the Motley Fool's top analysts have identified five elite blue chips that they confidently expect to deliver outstanding long-term returns.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended Afren. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.