How to tell if a company’s in trouble, or just its stock
Broken shares or broken company? That’s the question every investor needs to be asking after Thursday’s CPI report, which showed a steeper-than-expected rise in inflation and sparked even more market volatility. The news essentially ensured that the US Federal Reserve would hike rates by another 75 basis points next month while doubling the likelihood of another hike in December. In this environment, nobody can be blamed for wanting to just liquidate their holdings and sit on cash until the Fed manages to rein in inflation. However, as we discussed during our “monthly meeting” on Thursday, the problem is not exiting the market. That’s the easy part, and you could do it now with relatively high confidence that there’s no reason for the market to rise significantly and sustainably anytime soon. But the tricky part is knowing when to get back in. The market tends to spot news and make moves before that news is widely known. So if you get the all-clear signal, you’ve most likely missed much of the recovery. That’s why we told the club members on Thursday that we weren’t going to fold our hand. We believe it is far better – and less risky – for a long-term investor to manage a diversified portfolio with cash and rebalance it opportunistically based on the data and prices the market is throwing at you. We say “less risky” because unless you’re a professional trader (and even then, your edge may not be as great as it was before algorithms took over), when trying to get in and out of the market you don’t have to only in terms of the company are right question, but also in your timing. Additionally, this type of market participation requires your full-time focus. Crucially, trying to get in and out based on data like a CPI report will push your emotional control to the limit — and that’s half the battle when investing in stocks. Shares fell on Thursday on the CPI data before staging a rebound later in afternoon trade. The S&P 500 rose nearly 3%. So if we don’t fold our hand, what then? That doesn’t mean we just jump in. Instead, knowing there’s no rush to get in right now, let’s look for broken stocks in still-strong companies. Now, when we talk about companies that are still strong, we’re referring to their financial health and ability to weather an economic downturn, as well as their longer-term profitability. The former is easily determined by examining financial statements, as we have recently outlined. The latter is a bit more abstract and requires one to think qualitatively about the business in question. For example, a company may currently have a strong balance sheet, but if consumer preferences change in a way that could result in lower demand in the future, this could adversely affect longer-term profitability. Club Holding Meta Platforms (META) is a perfect example. Currently, a debate rages on as to whether the tech giant is a busted stock or a busted company whose shares are down more than 60% year-to-date. Some will argue that this is a business in decline, run by a CEO who has his eyes off the ball. And with increasing competition, its share of the advertising market and social media users is at risk. If that’s your perspective, you’re more inclined to view meta as a broken company and therefore untouchable. On the other hand, if you believe that meta management is investing in the future – as we are – and that they will do to Reels what they did to Stories (fight off the competition and increase engagement and monetization over time) on their platforms , then you would probably think longer-term profitability and cash flow generation would bounce back. In that case, what we have here is a broken stock, not a broken company. Other cases may be clearer. Take our recent case study from AMC Entertainment (AMC). Financial conditions are dire and consumers are clearly forgoing expensive cinema visits, opting instead for an at-home streaming experience with their snack of choice at supermarket prices. That doesn’t bode well for the topline given the financial position and demand dynamics. AMC is clearly a broken company — at least for now. Of course, once you’ve determined whether it’s a broken stock or company, the next step is to consider the valuation. As we’ve said throughout the year, no matter how big the promises made by management, what we want is real cash gains. With this in mind, we focus on earnings-based (price-to-earnings) valuations. Additionally, we have to acknowledge that given today’s CPI pressures, the Fed’s expected response, and the simple fact that the analysts making these estimates are behind the all the way down, all the estimates we’re looking at now are behind the Curve lagged may still be too high. Therefore, you should be even more rigorous in evaluating who you are willing to pay for everything. This is one of the reasons why we decided to forego our intended purchase of additional shares of Linde (LIN) on Thursday, which we discussed during the monthly meeting. By the time we discussed the move, shares were down $1, but by the time we decided it might be the right thing to pull the trigger, the stock was up $8 — and this isn’t a market to get your head around can afford to chase. Ultimately, we are in a brutal market. There’s no denying that. But rather than trying to exit and then being forced to find just the right moment to re-enter, we think the best course of action is to simply hold a diversified portfolio of quality companies. And at the same time, we’ll continue to look for broken stocks with robust earnings power. (Jim Cramer’s Charitable Trust is long META, LIN. For a full list of shares, click here.) As a subscriber to CNBC Investing Club with Jim Cramer, you’ll receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling any stock in his charitable foundation’s portfolio. When Jim spoke about a stock on CNBC television, he waits 72 hours after the trade alert is issued before executing the trade. THE ABOVE INVESTMENT CLUB INFORMATION IS GOVERNED BY OUR TERMS AND CONDITIONS AND PRIVACY POLICY ALONG WITH OUR DISCLAIMER. NO OBLIGATION OR OBLIGATION SHALL BE OR CREATED BY YOUR RECEIVING OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC RESULT OR PROFIT IS GUARANTEED.
Federal Reserve Board Chairman Jerome Powell speaks during a press conference following a meeting of the Federal Open Market Committee January 29, 2020 in Washington, DC.
Samuel Korum | Getty
Broken shares or broken company?
That’s the question every investor needs to be asking after Thursday’s CPI report, which showed a steeper-than-expected rise in inflation and sparked even more market volatility. The news essentially ensured that the US Federal Reserve would hike rates by another 75 basis points next month while doubling the likelihood of another hike in December.