Recovery investing is a challenging strategy, but these 10 rules could help investors spot opportunities
Recovery investing has come into its own in the past decade, becoming as recognised as value and growth styles following the credit crunch and subsequent financial crisis.
Recovery stocks have particular traits that investors must look out for. They are companies whose profits are depressed due to either economic or sector dislocation, poor management decisions, or a combination of both, and investors must find those that are poised to turnaround their profitability.
The key is to recognise this potential before other investors do, and to capture the upside in terms of share price gains when the turnaround is eventually recognised.
Nonetheless, recovery investing has always been – and remains – a challenging area for investors, with timing, technology threats and management changes all areas to be considered.
Having launched our strategy a decade ago, there are a number of key pillars of recovery investing which still hold as true today as they did in 2008. Below are our top 10 key rules of recovery investing.
1. Spotting recovery potential
We define recovery shares as those that have a strong business franchise and a depressed level of profits and, consequently, share price, but also show clear signs of being able to grow those profits to a more normal level.
2. Don’t try and buy at the bottom
When we invest, we need to see evidence that things have already started to improve. Investors are always loath to miss out on any upside, but it is important to make sure a business has bottomed out and is starting to recover, so we rarely invest in firms until we see signs that the company is in the recovery phase.
3. Management buy-in is key
The catalysts for recovery are most often self-help, and that typically comes from new management as well as economic and sector stabilisation.
4. Get the timing right
Timing is as important as assigning a valuation to a company. One thing we are not is ‘deep value’ investors, and while value defines how much money you can make, timing decides whether you make that money now or you have to wait two or three years.
5. A crisis is a recovery investor’s friend
The more economic or sector dislocation there is, the more recovery shares there are to choose from. Hence, the global financial crisis was a particularly opportune time for hunting for recovery investments. Since then we have had the sovereign debt crisis, the implosion of the commodities bubble, Brexit and now the Trump trade war, all of which have created opportunities.
6. Recovery stocks are still abundant
We have been surprised just how depressed valuations were after the global financial crisis, how long it has taken for the investment world to recover from it, and the ongoing focus on growth companies. Ten years on, many opportunities remain for companies to recover from different events.
7. Unrestricted investment landscape
The great thing about recovery investing is that, as long as you are sector and style-agnostic, there are always opportunities. Companies’ fortunes will always wax and wane, but as long as there are catalysts for change – something we very much incorporate into our investment philosophy – then opportunities abound.
8. Keep pace with technology
Recovery investing is about looking for opportunities where businesses are out of favour, but investors have to be confident that the business can actually recover and is not in structural decline. The rapid pace of technological change has made this all the more important, as there is a risk that investors may overlook the negative impact technology is having on specific industries. While there have always been periods of technological change, we are currently seeing a faster period of evolution than we have seen before.
9. Think long-term
Make no mistake, recovery investing this is not about making short-term gains from oversold stocks, but about businesses implementing fundamental changes to their DNA in order to turn around their fortunes. That takes time, so investors must be patient.
10. Know your upside
We aim to find companies we believe will deliver returns of 100 per cent over a three to five-year timeframe, but in reality we believe a good recovery share should be a multiple bagger.
Hugh Sergeant is manager of the River and Mercantile UK Recovery fund