Investing can be challenging, especially when dealing with a company going through a crisis. Even the best investors can struggle to correctly assess the situation and make timely investments in such companies. In India, there are many examples of companies facing crises, with some presenting opportunities while others posing significant risks. Therefore, choosing the right investment strategy is extremely important. Here are some strategies and factors to consider before investing in a beleaguered company:

 

Analyze The Cause Of The Crisis

To analyze the cause of a crisis, investors should first determine the reason behind the plunge in the price of a stock. This involves ascertaining whether the fall is due to external factors such as economic downturn or industry-wide issues, or company-specific problems such as poor management or financial mismanagement. By doing so, investors can identify the root cause of the crisis and assess whether the company has the potential to recover.

 

Get A Grip On The Company

Once the root cause of the crisis has been identified, the next step is to research the company and review its financial statements to understand its current financial situation. Specifically, investors should look at the company’s revenue, profitability, cash flow, debt levels, and liquidity to determine if it has sufficient resources to weather the crisis and if it has the potential to generate profits in the future. Additionally, a thorough understanding of the company’s competitive landscape, including its key strengths, weaknesses and opportunities can provide valuable insights. This should include an understanding of the company’s products and services, market share, and customer base, which will help determine the viability of its future.

 

Look At The Company’s Management Team

The management or owners of the company play a key role in navigating a crisis, and their skills and experiences are essential. Therefore, it is important to understand their character, the governance, composition of the board, and track record of CEO, CFO and other key personnel. In 2015, Nestle, the Swiss food and beverage giant, faced a crisis in India when its Maggi noodles were found to contain high levels of lead and MSG  (monosodium glutamate).

As a result, the product was recalled nationwide, and many states in India banned its sale. During the crisis, Nestle’s management team was put to the test, and the company responded quickly. It initiated a recall of the product and worked with Indian regulators to address their concerns.

Additionally, Nestle launched a major advertising campaign to reassure consumers about the safety and quality of its products. Ultimately, Nestle’s management team successfully navigated the crisis by addressing the concerns of regulators and consumers and by working to regain trust in the brand. After passing all safety tests and regaining regulatory approval, the company relaunched Maggi noodles in India.

This move was well-received by consumers, and Nestle’s stock, which had corrected from around ₹7,500 to ₹5,000 during the crisis, has since rebounded majorly and is now worth ₹20,497 a share.

 

Determine If The Crisis Is Structural Or Cyclical

After gaining an understanding of the company and its management, investors need to dive deeper into the crisis. The first step is to evaluate the nature of the crisis and see whether it is structural or cyclical. A cyclical crisis is a temporary setback caused by external factors, whereas a structural crisis is a more fundamental problem that requires significant changes to the company’s operations or business model.

In the early 2010s, Colgate-Palmolive, the global consumer  goods company known for its toothpaste and other personal care products, faced a significant challenge in the Indian market as consumers shifted towards Ayurvedic products, based on traditional Indian medicine, rather than mainstream brands like Colgate. This represented a structural change in the market, requiring Colgate to adapt to the shift by launching its own Ayurvedic product line and investing in marketing and advertising to regain its market share at a time when competitors were speedily entering the market hurting Colgate’s already dented image.

Despite the uncertainty surrounding Colgate’s future prospects during the crisis, investors who recognized the cyclical nature of the downturn and believed in Colgate’s ability to adapt may have seen the stock price plunge as an opportunity to invest in a strong company at a discounted price. Colgate’s strong brand and adaptive strategy ultimately helped the company to regain its position in the market. This example highlights the importance of recognizing the nature of a crisis and assessing a company’s ability to adapt and recover. In the case of Colgate, its successful response to a structural shift in the market helped the company to not only recover but thrive, with the stock price increasing from around ₹300 a share to ₹1,550 a share currently.

 

Understand The Severity Of The Crisis

The severity of a crisis can make or break a company’s chances of recovery. The global financial crisis of 2008 serves as a prime example, with some companies in the financial sector succumbing to severe losses and even bankruptcy, while others were able to weather the storm and bounce back eventually. To gauge the severity of a crisis, several factors such as its depth, duration, and impact on the company and its financials should be considered.

During 2008 crisis, many debt ridden companies simply vanished, unable to recover. Similarly, in 2015, Renuka Sugars faced a severe crisis due to a combination of factors such as glut in the sugar market, a drought in India, and high levels of debt. The company’s stock price plummeted and it faced significant financial challenges. Even to this day, the stock has not recovered to its previous high. Investors should be cautious when dealing with such crises, as some may have deeper impact that may not be reparable.

 

Valuation

Before investing in a company that is going through a crisis, it is important for investors to determine its valuation. This involves analyzing the company’s financial statements to determine its intrinsic value, or the value of the company based on its cash flows and future potential earnings. Compare this value to the current market price to determine if the company under consideration is undervalued or overvalued. A company that is undervalued may present a good investment opportunity, as its stock price is lower than its intrinsic value.

 

Do Not Catch A Falling Knife

Trying to catch a falling stock may be tempting, but it can be a risky strategy as there is no guarantee that the stock will stop falling. In the past, several companies like Yes Bank have failed, and investors who tried to buy their stocks at the bottom ended up losing money. Instead of taking such a risky approach, it is better to gather all the facts about the company and its crisis, analyze its impact on the company’s future prospects, and determine what is already priced into the stock. Investors should also wait for the stock to stabilize or show signs of recovery before investing, as this reduces the risk of losing money.

 

 

Consider What Is Already Priced Into The Stock

Once the crisis and its impact have been evaluated, the focus should shift to analyzing the stock price. It is important to consider whether the market has already factored in the crisis and adjusted the stock price accordingly. If the current stock price reflects the full impact of the crisis, the stock may not be undervalued and may not present a good investment opportunity. A recent example of a crisis that affected a stock price is the case of Yes Bank, one of India’s largest private sector banks, which faced a major crisis in 2020 when it was put under a moratorium by the Reserve Bank of India due to financial irregularities and deterioration in its financial health.

The stock price had already plunged, and many retail investors were caught in the fall. Initially, investors were not able to accurately price the risks associated with the crisis, as the bank’s financial health and management issues were critical. They could not assess the potential for further losses and write-offs, as well as the impact on the bank’s reputation and future prospects, requiring significant capital infusion and a longer, painful and a very uncertain recovery. Thus, it is important to consider all the factors before making an investment decision.

When Valuing, Think Like Graham In Terms Of Real Hard Assets

Benjamin Graham, widely regarded as the father of value investing, emphasized the significance of assessing a company's real hard assets, including property, plant, and equipment, when making investment decisions. This approach holds particular relevance when investing in a company that is currently facing a crisis, as negative market sentiments can lead to undervaluation of a company's assets. By diligently valuing a company's assets, investors may be able to identify potentially lucrative investment opportunities that others may have overlooked. This can help investors make informed decisions and possibly benefit from undervalued assets of the company.

 

 

Keep Some Cash For Volatility

Investing in a crisis-hit company can be volatile, and the stock price may fluctuate sharply. Having cash on hand is crucial to take advantage of buying opportunities or weather short-term losses.

 

 

Do Not Go Overboard

Investors must avoid going overboard when investing in a company facing a crisis. It is advisable to invest only a portion of their portfolio in the stock and diversify their portfolios to minimize risks. Despite having sound knowledge, unexpected situations and uncontrollable factors can cause assumptions to go awry. In such cases, investors can face losses for being wrong. Therefore, it is crucial to diversify the portfolio to mitigate risks and safeguard investments against market uncertainties

Think In Terms Of Probability

Many astute investors, such as Howard Marks and Warren Buffett, think in terms of probability when making investment decisions. When investing in a beleaguered company, investors must, therefore, determine the likelihood of the company’s recovery and weigh the potential risks and rewards. They must also consider the worst-case scenario and decide whether they are willing to accept the potential losses. This approach can help investors make informed decisions and develop investment strategies that suit their risk tolerance and investment goals. By placing the right weight on their investments, investors can minimize potential losses and maximize potential returns.

Size Your Bet Accordingly

Once investors have analyzed the potential risks and rewards, they must size their bets appropriately. Investors should only invest an amount that they can afford to lose and determine the appropriate percentage of their portfolio to allocate to the stock. They should consider the potential risks and adjust the size of their position accordingly. This approach can help investors avoid taking excessive risks and protect their portfolios against potential losses.

When In Doubt, Stay Away

If investors are uncertain about an investment decision, it may be best to stay away. They should not let the fear of missing out or the pressure to invest cloud their judgment. Instead, they must wait until they have a better understanding of the situation to make a more informed decision.

Gut Feeling Is Bad In The Stock Market

Relying solely on gut feelings or intuition when investing in a crisis-hit company can be dangerous in the stock market. Investment decisions must be based on thorough research, analysis, and sound reasoning. Investors must avoid making impulsive decisions that are based solely on emotions or intuition, as this can lead to poor investment choices and unnecessary risks.

 

Be Extremely Careful In Reading News Flow During The Crisis

During a crisis, there can be a lot of news and information circulating about a beaten-down company and its prospects. It is important to be extremely careful when reading news and to evaluate every piece of information with a critical eye.

News outlets may have their own biases or agendas, and some may report incomplete or inaccurate information. As an investor, it is vital to gather information from multiple sources and to carefully consider the reliability and relevance of each piece of news.

 

 

Think Independently And Evaluate Every Bit Of News With A Pinch Of Salt

Investors must consider the source of the information, the context of the situation, and the potential impact on the company's prospects. They must be wary of sensational headlines or information that seems too good (or too bad) to be true.

Therefore, it is essential to question the validity of the information and seek confirmation from multiple sources before making investment decisions. This way, investors can make more informed decisions and reduce the risks associated with investing in companies going through a crisis. By analyzing news with a critical eye and conducting thorough research, investors can make informed investment decisions and avoid potential pitfalls.

 

Do Not Allow Your Biases To Misjudge The Situation

Investing in a company facing a crisis requires being mindful of personal biases that can cloud one’s judgment. Such biases can cause overconfidence, groupthink, and herd behaviour, leading to detrimental investment decisions. To avoid these pitfalls, it is essential to maintain objectivity, keep an open mind, and adjust assumptions and conclusions as new information arises. By doing so, investors can make more informed decisions and improve their chances of success.

 

 

 

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