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Posted on 26 Sep 2017 by Alex Shevelev

Sifting Through Fallen Angels

Sifting Through Fallen Angels

Buying unloved stocks is part of the DNA at Forager. Most of the funds’ excess returns over almost eight years have come from buying stocks that other investors hated at the time we acquired them. Think Service Stream in 2013 or Cardno in mid-2016.

One simple way of finding these types of investments is to filter the market for stocks that others have been aggressively selling. Most value investors are regularly looking at a list of stocks trading near their 52-week lows or stocks that have fallen 40%, 50% or more from their highs. Lists like these focus our attention on stocks and sectors where others are more likely to be fearful. For us it can be time to be greedy.

Does buying the bombs work?

If you test this as a broad strategy, however, there is little evidence to suggest it works.

Take ASX stocks with a market capitalisation over $50 million which had fallen more than 50% over the past year. Simply buying an equal amount of each stock on this list every month nets the investor a loss of 77% over 5 years. More than three-quarters of your money dusted. And these were years in which Australian stocks rose over 10% annually. Over the past 10 years this list would have done even worse, losing over 90%.

But some periods stand out. It will surprise no one that late 2008 and early 2009 was a great time to be looking for bargains. At the time, there were more than 200 ASX-listed stocks which had more than halved over the previous year. Bankruptcies and desperate capital raisings filled the front pages. Investors were scared.

This brought with it the chance to buy stocks very cheaply. CBA shares were selling for $25 a piece. Wesfarmers‘s stock touched $15. Many smaller companies saw their share prices fall much further.

Fast forward to 2012 and early 2013 when investors were again able to choose between 50 and 100 big decliners. Miners and the companies that service them dominated the list. In 2015 investors had another 50+ stocks to choose from. Miners and mining services were still suffering. Non-mining names like WPP (the old STW Communications) and Metcash also began to pop up. Many of the past year’s best performers for the Forager Australian Shares Fund were acquired during this period.

Sifting Through Fallen Angels

As a general rule, then, the time to be sifting through the list of fallen angels is when there are many of them.

Where are we now?

At the end of last month there were 30 stocks which had fallen 50% from their highs in the most recent year, some of which were highlighted on a slide in our recent roadshow presentation. The list included former high flying telcos TPG and Vocus, drug maker Mayne Pharma, and media monitor Isentia.

Thirty stocks is a much lower number than the historical average and that is perhaps why there isn’t much to get excited about. Even after halving most do not appear overly cheap. In optimistic markets, fallen angels are fallen for a reason.

Sifting Through Fallen Angels

8 thoughts on “Sifting Through Fallen Angels

  1. Thanks for the post Alex, I certainly didn’t expect the results to be as bad that, particularly in a mostly favourable market. Out of curiosity, what software do you use to run such a list and also backtest that strategy?

    • Hi Matt. We ran this one in Bloomberg. It is worth noting that backtest doesn’t presuppose any particular holding period, so once a stock is no longer down 50% from a year ago it comes off the list.

      • Is this point about stocks dropping off the list when they are no longer down 50% YoY perhaps a structural problem with the screen/backtesting methodology here? I wonder what the results would look like if you looked at the subsequent returns from holding a basket of these stocks for 12mths vs. the market, or 2-3yrs vs. the market? Would be interesting to see if it yielded the same results. I personally suspect it would not.

        Technically speaking your methodology is sound, but I would argue is likely ignores practical market factors like momentum (which is a real and statistically documented think in markets) and return asymmetry. Deep value stocks outperform in the aggregate but often with very asymmetric payoffs, with a few very significant & concentrated-in-time wins (e.g. Whitehaven) offsetting long periods of decline or stagnation. By removing stocks as soon as they start to recover and are no longer down 50% YoY, you are truncating the fat tail recovery returns in the stocks that drive most of their outperformance.

        That being said I completely agree (pending any data that invalidates it) with your conclusion. In expensive markets where relatively few stocks are down, the stocks that are down are invariably down for a reason and usually the most dangerous stocks to bottom fish. When people are desperate for returns because the market is overvalued they neglect these stocks for good reason. Not the same when value is on offer everywhere.

        My guess is that if you run the screen using 12mth or 24-36mth returns you’ll probably see a slight outperformance of the group over 24-36mths, but may see some where to zero to slight underperformance over periods less than 12mths. Studies indicate momentum factors generally persist for about 12mths after a 12mth period of pronounced variant returns has occurred (i.e. strong stock trends last about 24mths in average).

        Would be interesting to see if the data confirms these speculations.


        • Hi Lyall. All fair points, especially around the methodology. The contribution is likely to be very stock specific and in this simple backtest the contribution of strong performers will be cut off too soon. I might try to fiddle around with the holding period as you suggest (but no guarantees).

  2. Not great analysis IMO. Buying unloved stocks can work but (of course) you wouldn’t buy every stock that has dropped by say 50%. You do need to review why each stock has fallen and screen out the dogs otherwise of course you will lose money.

    • Hi Grant. Sure, you wouldn’t buy every stock that had dropped by 50%. We, like many others, look at the list of poor performers for the potentially unloved and cheap. Of course, that is only the start of the process. There is plenty more work to do. When there are more names on the list though looking at it is likely to be more fruitful.

  3. Its useful analysis to do.
    By knowing what the expected return may be across the broader range, you can identify whether the odds are against you from the start and be even more careful in your choices.
    It also allows you to potentially isolate subsets that may stand out or skew the results (such as 2008-09 period or specific sectors).

    It would be interesting to find out the expected returns of stocks that had risen by more than 50%. Above logic would suggest they would outperform, but reality and experience tells me otherwise.

    This analysis suggests you could buy every stock that hadn’t fallen by 50% and you would outperform the average by default. You’d probably want to do a bit more research before incorporating this strat into the Fund!

  4. Any tips from anyone, on specific out-of-favour stocks?

    Personally this is my preferred investment category. Three of my current positions in this space are MRG, FLN and QHL – though all somewhat speculative.

    MRG’s risen a lot in the last few weeks though – so you may’ve already missed the boat? But I still think there’s plenty of upside left anyway. FLN and QHL (I’ve held this for a long time and they’ve made progress, but it’s only gone down. New Management appear to be more shareholder-focused – though early days in their tenure) haven’t moved much though.

    Anyway – my 2 cents (FWIW) – do your own homework, cause I’m no financial professional.

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