Another great guest blog post from a new trading challenge student:
In the last few weeks two companies with terrible fundamentals got some news that sent them flying. What is worse is that you could have seen these catalysts coming. See you may not engage in rigorous fundamental analysis when short-term trading, but finding stocks with weak fundamentals that have been extremely and quickly punished can be a fruitful endeavor.
Alcatel-Lucent (ALU) and Advanced Micro Device (AMD) recently announced news that they have delayed falling onto the spike floor. So far there has not been much in the way of avoiding the spikes. It sounds like jumping off a plane in middle of the ocean with no one around. This time you have a parachute, which means that the impact won’t kill you. However, you are likely to drown. That is a dark metaphor but that is the dire straits these companies are in.
Alcatel-Lucent just secured financing from Goldman Sachs and Credit Suisse that gives them the ability to pay off debt with newer debt and fund the costs of restructuring. The Goldman deal was in the talks phase for a while. It seemed fairly obvious that they would secure the agreement. ALU might be a company on the decline, but it does have some exceptionally valuable assets with which to secure the debt. I knew it was a lock. Sure the price rose a bit when there was news of talks, but it rose and fell back to the normal level for the last few weeks, which was around $1, though sometimes $1.12.
The announcement itself led to gains of 5% and more in the days after. Now ALU is up almost 50% from where it was a month ago. Considering the pummeling the stock has been taking it is not surprising. It is even less surprising when you consider how there were numerous concerns over the company’s liquidity. Securing this financing agreement really pushed away one of the biggest concerns. Even people who thought the company was salvageable were worried that it did not have the cash to survive long enough to set itself straight. This has led to a rise in sentiment. This was largely predictable.
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AMD is another company that has had some issues, though not as serious as ALU. AMD’s problem is shrinking business and the risk of losing to a larger competitor. AMD has had shrinking revenues and even with expense cuts, shrinking revenues are a problem. AMD does not have serious liquidity concerns, but it does have quite a bit of debt. In order to secure a lifeline, institutional investor Mubadala Investments took a larger stake in AMD. The market has concluded that Mubadala would step in to bailout the company if necessary. This means that AMD will not get to that level of fear regarding liquidity that ALU got to.
This move was a bit more swift than the Goldman one. There was news about ALU talking to Goldman for a while and there was time to get a nice position. The AMD one was a bit quicker, but if you were on top of the newsfeed you had a nice chance to get in before it popped then declined and has risen throughout the last two weeks. The gains for AMD were much more muted, though there was a ramp up into the news that was release on December 8th. You have to have been on top of the news to really see any hints. ALU was far easier.
The lesson to be learned is that is short-term potential in these efforts by damaged companies to give themselves breathing room. There are also other pieces of news that can be beneficial like a new big deal, or otherwise. If the company had declined rapidly, then there is a chance for swift bounce back when any positive news hits.
To find companies like this you want to look for companies making new 52-week lows rapidly. In the best situation the 52-week high and the 52-week low should be only about 3 months apart. This is rare, but it shows that a company was stagnating for a while before being brought down by rough news. That is an ideal situation but in general a quick decline to make a new 52-week low is something to take a note of. If the company has been grappling with problems for the last few months, then there are probably plans to rectify the most serious problems. This is a form of triage. ALU was declining because of serious liquidity concerns the Goldman deal serves more as a way to stop the bleeding. ALU would not have needed the money for years.
Just find these companies and find out why they declined, because something can’t be fixed. Normally you are looking at chronic problems not things like accounting errors/fraud or being hit by a major lawsuit. The situation has existed for a while and has finally taken down the stock with a vengeance, but it not an inevitable or intractable problem. These two companies are a good example of that. Their concerns could be eased by finding a financier.
These are quick trades that can net you 10% or more. ALU could have gotten you 30% or more over a the course of a few days, and the stock is still going strong. Do not over reach though you are just looking for a nice fast return for your risk and then pocketing your winnings and moving on. If the run gets too ridiculous turn around and short it. If ALU gets to $2.00, I would short into the next earnings report, because they are going to have a hard 2012. 2013 might look brighter, but this past year will be a rough one.