Aesop’s fable tells of a boy that cries wolf just for the fun of watching the panicked villagers tear up the hillside to save their flock.
But when the wolf finally arrives, nobody listens to the boy’s plaintive cry. The sheep get savaged.
The story reminds me of the plaintive cry of a company CEO, only it’s the other way round with these boys…
When companies issue a profit warning, the CEO nearly always tops it off with a message like: “oh, we’ve had a little hiccup, but don’t worry – we’ll set it right – there’s no wolf”.
Then, wouldn’t you know it, a second warning almost always follows… “Oh, we’ll get over this, in fact we should look to the positives… blah, blah, no wolf, blah”.
And if you’ve had two warnings, why not a third? Bad luck comes in threes after all.
But by the third warning, the shares are pretty well pulped.
The interesting thing is that this may be the very time to buy the company. It doesn’t work in every scenario – you have to believe in the business, but it’s an old City trick that many investors are unaware of. And I’d like to show how we could use it to trade a disgraced blue chip for a tidy profit.
The City’s lesser known adage
The City, being the City, is a land full of sceptics. They know the fable – and will never give a CEO the benefit of the doubt.
But the City has a lesser known adage that might just as well have been written by Aesop: ‘Sell on the first profits warning and buy on the third’. And it is a very useful adage. You see on the first warning, a fund manager will often simply dump a stock and ask questions later.
Most fund managers hate to hold shares with ‘bad news’ attached. It’s like the stock is ‘contaminating’ their portfolio – it looks bad! So within an hour of the announcement a share price is usually trashed.
Just imagine old ‘pin-stripe’ going into a meeting with a niggling trustee of a pension fund (and yes – I’ve been there). Old niggly would admonish him for being overweight on BP and point out that the shrewd players dumped BP the moment trouble was in the air (oil spills and all that). And that pushes the price down further.
But a stock price can be like a spring, you can only compress it so far.
Three is the magic number
As you can imagine, management hate to deliver a profit warning. And you can bet your bottom dollar they’ll hold off publishing it for as long as they can.
Take BP. As news of the Macondo spill erupted, BP traded at over £6. Management played down the affair and hoped to clear things up without too much trouble. I remember analysts interpreting the news as a few billion dollars in clean up costs and that was ‘the worst case scenario’. We were talking about 50p off the share price.
But, let me tell you, at this time the clever boys did their selling. As the oil gushed, so came the reprisals. And the stock carried on down and down.
Warning two came with the news that the US government was going to ‘kick ass’ over this mess. The shares headed to £5 and then came £4.
Yet BP still refused to see the wolf. Rather than cap the dividend, they concerned themselves with capping the well. They hadn’t cottoned on to the political side of the affair… Hayward wanted ‘his life back’ and all of that. The situation just got worse and worse…
In the end the whole thing blew up and CEO Tony Hayward walked the plank. The shares hit rock bottom at just under £3. That was the third warning.
That’s the time to buy
Now I’m not saying that there’s a silver bullet here – there’s no guaranteed buy signal. For BP, I’ve kind of made up my own ‘three warning waves’ from what was in actual fact a slew of daily information.
But the idea of buying on the third profit warning can be a good one. It plays on a part of the human psyche that Aesop picked up on.
Three strikes and you’re out!
It leads many investors to dump stocks at the bottom. After three chances you’ve just about had enough. Damn your shares and damn your lies.
And if you ask me now if I’m keen on BP? I’ll say yes. It seems to me that BP’s had its three strikes. Too many consider the ‘boy a liar’.
Just look at the facts: oil prices are on a tear. And I think we’ll probably see BP’s dividend reinstated soon. The wolf stories seem distant now.
Forecasts suggest BP will be earning 67 pence per share this year and about the same next. Even though they’re only forecast to pay out 27p of that, you’ll be getting over 6% in return.
This is too tempting to resist.
I’d make the most of the fund managers that are too embarrassed to have BP on their books. At £4.25 BP’s a buy.
Source: Barclays stockbrokers
BP five year performance: 2005 +21.85%| 2006 -8.32%| 2007 +8.37%| 2008 -14.47%| 2009 +14.07%| 2010 -31.06%
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