Why stocks plummet on good news — and what you can do about it…
Shares in the life-sciences company Abcam fell by 15 percent when it published its full year results this week. At one point during the day, its price was down by more than 30 percent.
For random observers (who may not have even heard of Abcam), the cause of this savage drop might have looked obvious — the antibody specialist must have undershot expectations. But that wasn’t the case at all. Abcam’s results were in line with forecasts. Revenues were up, targets were hit and even the dividend was hiked by 18 percent. So why did the price tumble so sharply?
The answer was that Abcam said it was planning to invest more in research, development and expansion. Inevitably that would put pressure on earnings in the coming years, and it was this that rattled the market. Pressure on earnings is not something that Abcam shareholders are used to.
Good news… bad reaction
It’s quite common for investors to be left bemused when share prices fall on what seems like decent financial results. The causes vary, but Abcam is an interesting case. With a market cap now of £2.7 billion, it’s one of the largest companies quoted on the Alternative Investment Market (AIM). It’s also one of the most profitable. In fact, Abcam has a solid track record of growing profitability, cash generation and efficiency. This has made it very attractive to many investors. But its popularity meant it was particularly vulnerable to a stomach-churning price drop, and here’s why…
Abcam belonged — and still belongs — to a group of stocks with an investment profile we call High Flyers. They have some eye-catching quality characteristics, meaning they’re profitable, often resistant to competition and financially robust. A reputation for quality earns them support in the market. Consistent overachievement in earnings growth makes them popular. And that manifests itself in relentless price momentum.
So stocks like Abcam are appealing for their good quality and strong momentum. But the flipside of the coin is that they can end up looking expensive against regular valuation metrics. But some investors believe that eye-watering prices can be justified if earnings in a company are growing rapidly.
It was that kind of momentum that propelled Abcam’s shares from £5 to £15 in a little over three years. In that time, its average price-earning ratio was well over 20x, and last year it hit 68x. But when the market senses the growth might falter, those kinds of valuations can looked stretched. Thereafter, the momentum crash can be swift and startling — and that’s what we saw.
How to handle high flyers
Although severe, the price fall at Abcam only wiped out three months worth of gains. Holders of the stock now have to decide whether the company’s high flying growth profile could be at risk of changing. Some companies can sustain their high quality, strong momentum (but often expensive) profiles over many years. Just a few past examples include the likes of Domino’s Pizza, JD Sports, Next and Rightmove. These kinds of stocks can compound returns over long periods but they need to be watched carefully. When the investment case does change, their expensive valuations can lead to sudden price reversals.
You can filter any UK or international market on Stockopedia for High Flyers (or any other of the StockRanks-powered style classifications) using the StockRanks portal. I’ve got a quick High Flyers screen here, too. Here are some of the names currently leading the list:
For some, a few of the stocks here won’t come as any surprise. Companies like Craneware, Electrocomponents, Victrex, Hargreaves Lansdown and Burberry have strong reputations for the gains they’ve churned out over many years. It’s worth saying that Abcam was fifth on this screen the day it disappointed investors. But rather than a failing, the events at Abcam are a reminder of the hallmarks of High Flyers — both good and bad.
In bullish conditions these types of firms can see their momentum accelerate as investors move into the market. Their quality should, on average, mean that they are less likely to deliver nasty surprises. But missed expectations, changes in management, strategy or trading conditions can unsettle the market. As investors in Abcam found out, the impact can be considerable. The question then is whether the investment is likely to change or if the market is offering a momentary chance to buy at a slightly lower price.
Originally published at www.stockopedia.com.
Disclaimer: This content should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.
