Editors Choice

Wednesday, 31 May 2017
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Event Risk

The frequency of “shock drops” in share prices has significantly accelerated in the last year, a function of continuous disclosure requirements, companies cannot ‘leak’ they have to dump, and a function of the algorithms. Over 50% of orders placed on our screens are now done so by computers and selling triggers selling without analysis, humans or emotion in the way to stop it. Even the biggest stocks are not immune from shock and as the market’s speed of reaction has shortened to nano-seconds, ‘shock’ price movements have become a fact of life.

This “Event Risk” has driven many of you away from stocks, particularly illiquid, mid-cap and small growth stocks, and into the marketing arms of products like ETFs and managed funds, not to mention hybrids, property and cash.

High risk takes a lot of the ‘fun’ out of investment, never quite knowing when you are going to get blown up is not a pleasant back drop. In the ‘old days’ you could expect to get winged in the fleshy part of the left arm by a few bullets now and again, but these days you can turn on your screens to find you have already been obliterated by a pre-market announcement before a share has even traded.

This heightened risk means that a very useful investment process is to build a watchlist of stocks that are safe. They are not hard to spot. They include any company that has recently updated the market on earnings expectations. In so doing a company immediately de-risks itself, at least for the next few months, in which case, in the short term, you can quite freely trade, look at the charts and believe the trend, and, in the longer term you can have some mild faith in the fundamentals, make judgements on the numbers and rely on the dividends.

But if the company is three months or more out from an update, or worse, a week away from results, having said nothing for 6 months, beware. The chances of it blowing up in your face are higher.

How do you combat this risk? It’s fairly easy. Go to the announcements, go to the company website, Google the CEO. Look for any commentary in the recent past that would lead you to believe the company are travelling OK. Even if its six months old, it tells you something. 

JB Hi-Fi fir instance looks terribly cheap if the forecasts are right. The stock is down 25% from its high and if they hit consensus forecasts the stock is on just 12.6x with a 7.2% fully franked yield, it is trading 18% below the average broker target price, it is trading 37% below intrinsic value, it has a return on equity of over 25%, manageable debt and a $2.6bn market cap.

But at the moment the share price is running scared of Amazon’s eventual arrival and an earnings disaster to follow. But Amazon has yet to arrive and it will be a year before any significant impact on earnings. Prior to that they have results in August and the opportunity now is that if they can hit earnings expectations the negative sentiment will dissipate, at least for a while, and the ‘value’ will reassert itself.

But what are the chances of them hitting consensus expectations? What is the threat of a results driven event risk? And this is the game, in a dangerous market, you have to assess your event risk first, the stock second, and you do that by seeking out the latest earnings guidance or commentary.  

In this case a quick search will tell you that JB Hi-Fi put out a presentation to the Macquarie Australia conference on May 3. The share price rose that day and for the next two days. Their outlook statement said group underlying NPAT guidance was for $200m to $206m, an increase of 31.4% to %35.4% on the pcp.

NPAT up 31.4%, at least, and that comment is less than four weeks old. On that basis the “Event risk” is low. Job done. Now all you have to do is decide ‘when’ to buy. That’s easy. Wait for someone else to buy it first then follow them in, because as any trend follower will tell you, it’s no good being right when the whole herd is wrong, and the whole herd can be wrong for a long long time.


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