The weekend before Thomas Cook finally went bust, I heard people suggesting it could be the perfect time to get in at the bottom and make maximum profit from a potential recovery.
The shares had closed at 3.45p and, sadly, they never made it back. But they’d fallen from around 135p in May 2018, so it’s easy to see why people might have harboured thoughts of a big recovery.
All the way back?
Thinking a fallen share price like Thomas Cook’s can recover all of its loss when the company gets back on its feet is a common, but usually mistaken, belief — because it ignores the dilution effect of any bailout. Even if a company does regain its pre-trouble market capitalisation, the rescuer will now own most of the shares, not the original owners.
Earlier in the saga, when it looked like the Fosun deal was going to save the day, investors were buying at around 6p or so in the hopes of a recovery profit, but even then I was warning against what I saw as a dangerous gamble. My rule of thumb if you’re considering investing in a bailout situation is — never, ever, buy until the rescue deal is signed and delivered, and the bailout cash is actually in the bank.
More generally, I’m becoming increasingly cautious when it comes to potential recovery plays. When I see a company in trouble and offering a tempting investment, I won’t touch it until I see the recovery is actually happening, until profits have started to improve, until debt is being tackled, and until the balance sheet looks safe. That approach guarantees I’ll miss the bottom and the maximum possible profit, but it greatly reduces my chances of a wipeout.
How does Sirius Minerals (LSE: SXX) fit in? Sirius wasn’t a previously high-flying company that had gone off the rails, and wasn’t a recovery situation. But it did face what is effectively the same issue as Thomas Cook, and that’s the need to get investment cash from a third party. We knew the need was coming, but those of us who invested were confident the funding could be raised
Would my ‘no recovery stocks’ rule have saved me from the 84% loss I’m currently sitting on? If I’d generalised it to ‘Never invest in a company until it has the cash it needs to secure its long-term solvency’ then yes, it would. For risk-averse investors, and especially older investors who usually have a greater need for income and who have fewer decades ahead of them over which to even out the effects of bad investments, I think adopting such an extended rule could be a very good idea.
And I do fit the older investor category, so why am I not going to be so strict? The simple fact is that I still enjoy a small growth stock investment from time to time, and instead of trying to eliminate the risk by not buying them, I minimise it by only making very small investments. The cash I had in Sirius was only a small portion of my retirement pot and I was prepared to lose it, and that’s a firm rule I follow for any ‘jam tomorrow’ punt I might make.
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Alan Oscroft owns shares of Sirius Minerals. The Motley Fool UK has no position in any of the shares mentioned. 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.