Recovery investing is the art of identifying companies that are going through a difficult period. These investors continuously seek new investments to replace those where the recovery has manifested itself or where the recovery is unfounded. The emphasis is on capital growth and yield considerations are ignored.
These identified shares have suffered major setbacks and disasters. They often include companies that have strayed from their core business and “di-worse-ified” instead of diversifying.
Perhaps the board of directors have too much of a good thing, perhaps there was too much cash in the bank and the temptation to try something new was irresistible.
An expensive acquisition, a fancy, a space age new head office in Sandton and high levels of debt are always danger signs.
A company which has sold widgets for thirty years, has cash in the bank and an adequate head office above a hardware store is a better bet – but I digress – anyway, once the directors have made their mistakes and the nasty part is over, there is the potential for a turnaround. Here the recovery investor will step in.
The secret in recovery investing is to buy cheap. To buy cheap you need lots of bad news and most investors must believe the company is going bust. The recovery investor will determine that there is a reasonable chance (obviously more than fifty percent) that the company will recover.
While you want everyone to believe the bad news, you need to establish whether or not there is a solution to the problem. Normally the solution is money, new management or time.
There must be a sound, jewel of a business, worth saving, somewhere in the rubble. There must be asset value, cash flow, a good revenue line, excellent cash flow management and debt that is not impossibly high. New management is very important and the right people will make the critical difference. They need to be enthusiastic and have their own money invested in the company.
The most interesting factor about recovery investing is that the price movements of these shares are not correlated at all to the market trend. These shares can move sharply higher even in falling markets and are very profitable, sometimes gaining more than ten percent in a single day!
You CAN count your chickens before they hatch!