Why 15% Drops Aren’t Always a Sign to Sell Stocks

by Will Ashworth | December 24, 2013 6:00 am

Tesla’s (TSLA[1]) stock dropped by 15% on November 6 after reporting Q4 guidance[2] that investors felt was a little weak. In the blink of an eye its stock went from $176 to $151. Was that a buying opportunity? I thought so. Since then, however, TSLA stock has been as low as $116, suggesting investors aren’t convinced.

moneybuysell Why 15% Drops Aren't Always a Sign to Sell Stocks[3]For the long-term (3-5 years), I believe those brave souls who bought immediately after the drop will be handsomely rewarded. To prove my point I’ve found a few examples of stocks that experienced large, short-term hiccups (a 15% drop in single month of trading) only to recover nicely.

Buying sound companies on big dips strikes me as the Warren Buffett way. If you do this for an extended period of time, you should come out a winner.

Doughnut Mania

krispykreme185 Why 15% Drops Aren't Always a Sign to Sell Stocks[4]Krispy Kreme (KKD[5]) dropped 21% April 1, 2011 on an unexpected Q4 loss of two cents per share — six cents worse than analyst expectations. By the end of the day, KKD stock was trading at $5.56 per share. A similar drop occurred  on Dec. 3 of this year when the doughnut shop announced 2015 EPS guidance between 71 cents and 76 cents, less than the consensus estimate of $0.77.

With same-store sales in the third quarter up 3.7%, its 20th consecutive quarter with positive comps, investors overreacted to the news. Finally, in late summer, its stock dropped 15% August 30 on earnings that were two cents short of analyst expectations. With KKD’s pricey valuation any excuse will send its shares down. That spells opportunity.

CEO Jim Morgan has performed a first-rate turnaround since jumping from the boardroom into the CEO chair in January 2008. A director since 2000, Morgan has brought a sense of focus and direction to the company and shareholders have benefited mightily from his leadership. Since he took charge, its stock is up over 1,000% through December 18 and that’s including the 20% drop in early December.

The earnings news isn’t nearly as bad as Jim Cramer believes it is[6]. Investors who were holding in August when its shares dropped below $20 should still be holding today. And if they were smart they would have bought some more then and again in early December. This is a company whose stock has demonstrated a bounce-back quality. It will be above $25 in no time.

Fickle Retail

EXPR185 Why 15% Drops Aren't Always a Sign to Sell Stocks[7]Anyone who follows retail stocks knows that investors are just as fickle as shoppers. Today’s darling — Michael Kors (KORS[8]) — becomes yesterday’s news — Coach (COH[9]) — and the merry-go -round continues.

Take Express (EXPR[10]) for example. Since its IPO May 12, 2010, its stock has crossed above and below its $17 offering price on several occasions. In November 2012 it dropped precipitously close to single digits. Anyone who bought near those lows has made out like bandits, notwithstanding the 23% drop December 4 on Q3 earnings that were fine but also included lower guidance for the entire fiscal year. Essentially, a six-cent difference in earnings for the year eradicated almost $500 million in market cap in a single day.

There are two big differences between this year and last. First, there were 53 weeks last year compared to 52 in fiscal 2013. Secondly, the retail environment this year has been far more promotional in nature, leading to lower margins. On both these counts there’s not much a retailer can do except offer the best merchandise possible so that the bleeding is kept to a minimum.

Since going public, EXPR has experienced five months with stock declines of 15% or more; on two occasions — October 2012 and December 2013 — its stock declined by 25% or more. In August 2010, Express stock lost 22%. By the end of the year its stock was 11% above where it started in the beginning of August of that year.

If you’d bought at the end of August you’d have been up 43% by the end of 2010. If you bought 100 shares of Express at the end of the month in each of the four previous monthly declines (not including this December’s recent drop) today you’d have 400 shares worth $7,380, 19% higher than your cost. It might not seem like much, but done over 10-20 years it adds up fast.

Changing Business Model

Angies List 185 Why 15% Drops Aren't Always a Sign to Sell Stocks[11]Angie’s List (ANGI[12]) is a consumer-review site where members rate businesses they’ve used, providing other members with valuable insights should they have a similar need. Its business has mushroomed since going public in November 2011. With something like 720 categories, it has grown well beyond its original handyman specialty.

ANGI is transitioning from a business model dependent on membership fees to one driven by service provider ads and e-commerce transactions it helps facilitate for those same service providers. A recent experiment in New York, Chicago and other large cities provided a 75% cut on membership fees for new members in those cities. InvestorPlace’s Tom Taulli says investors don’t like the proposed changes to its business model[13] as they promptly knocked its stock for a 15%, single-day loss this past October.

The reality, as Tom points out, is that its fees have to drop because others like Yelp (YELP[14]) are already providing reviews for free. Personally, I’ve always been skeptical of membership fees driving a consumer-focused business. This move (they’ve since stopped the experiment) should be positive in the long run, but investors viewed it the other way around, which spells opportunity.

Since going public, ANGI stock has experienced five monthly declines of 15% or more, and the average of those five declines is 25%. Once again, imagine that you bought 100 shares at the end of each of these months. Your cost would be $7,261 and your current market value $561 lower at $6,700. That’s not as bad as it sounds. One of the purchases was made in July 2013 at $22.02 per share, not too far from its all-time high. Assuming that its stock price got back to $22 by the end of 2015, your annualized return would be 13.6%. That’s pretty good in the real world.

Bottom Line: Carrying out this type of plan takes loads of commitment — it isn’t for the weak-kneed. However, if you can stick to a plan (and that’s a big if), buying on big price adjustments will produce above-average returns.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.

Endnotes:
  1. TSLA: http://studio-5.financialcontent.com/investplace/quote?Symbol=TSLA
  2. Q4 guidance: http://blogs.barrons.com/stockstowatchtoday/2013/11/06/tesla-disappoints-investors-analysts-not-so-much/
  3. [Image]: http://investorplace.com/wp-content/uploads/2010/09/moneybuysell.jpg
  4. [Image]: http://investorplace.com/wp-content/uploads/2013/09/krispykreme185.jpg
  5. KKD: http://studio-5.financialcontent.com/investplace/quote?Symbol=KKD
  6. Jim Cramer believes it is: http://www.cnbc.com/id/101277182
  7. [Image]: http://investorplace.com/wp-content/uploads/2013/07/EXPR185.jpg
  8. KORS: http://studio-5.financialcontent.com/investplace/quote?Symbol=KORS
  9. COH: http://studio-5.financialcontent.com/investplace/quote?Symbol=COH
  10. EXPR: http://studio-5.financialcontent.com/investplace/quote?Symbol=EXPR
  11. [Image]: http://investorplace.com/wp-content/uploads/2013/12/Angies-List-185.jpg
  12. ANGI: http://studio-5.financialcontent.com/investplace/quote?Symbol=ANGI
  13. proposed changes to its business model: http://investorplace.com/ipo-playbook/angies-list-angi-negative-reviews/
  14. YELP: http://studio-5.financialcontent.com/investplace/quote?Symbol=YELP

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