The market overreacts. This is probably not a new concept to you, but it is true nevertheless. Good news can drive a share price higher than it fundamentally should, and to an even greater extent, bad news can make shares fall through the floor, again, even if the move isn’t truly warranted.
Yesterday the software company Micro Focus (LSE: MCRO) saw its share price drop 30% after it issued a sales warning. As always, seeing the headline figures, my suspicion was that this may have been overselling. Already today, as I write this, the stock has gained 5% back on the day.
Fear vs fundamentals
The revision of sales figures was fairly mild, with revenues now expected to fall by 8% compared to previous estimates of 4%-6%, and in itself probably didn’t warrant a 30% sell-off. However the reason the market reacted so strongly, and perhaps a more legitimate reason, was because of troubles the company has been suffering for the past year or two.
Micro Focus said the sales revision was due to a slowdown in IT spending by European business, but the shares have seen a fairly turbulent few years following the company’s $8.8bn reverse takeover Hewlett Packard’s troubled software business.
This deal included the remnants of HP’s ‘Autonomy’ company, which it purchased in 2011 and was forced to write off almost the entire value due to accounting irregularities. The company’s finance chief was actually convicted of fraud, and its founder is currently facing a civil trial.
Insiders selling shares
Another concern for investors, and an issue that has to one extent or another been weighing on the stock, is the large share sales from Micro Focus Executive Chairman Kevin Loosemore. Nobody ever likes to see company insiders selling off their own stock, and so far this year, Mr Loosemore has sold about 60% of his personal shareholdings in the company, totalling £25.6m.
That said, according to the company’s statements and news reports, this selling comes not due to concerns over the company, but rather because Mr Loosemore has personal issues going on that require him to raise cash – we all have bills to pay after all. Interestingly CEO Stephen Murdoch also has bills to pay apparently, selling off about £5m of shares in April, which according to a Micro Focus representative, was to pay a tax bill.
Time to buy?
As I said earlier, this kind of large price drop always has me considering if a share is worth buying, even if I hadn’t particularly considered this firm before. Looking at some of the Micro Focus numbers, there are positives on show. Most notably for potential investors, the current dividend yield now stands at about 9.5%, and its forecast P/E ratio is in the region of 9, making it pretty cheap.
However, my overriding concern at the moment is that there may just be more uncertainty, and particularly more costs, yet to come. I do think yesterday’s sell-off was a bit much, but I am not quite ready to buy Micro Focus shares just yet, even with this price drop.
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Karl has no position in any of the shares mentioned. The Motley Fool UK has recommended Micro Focus. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.