When you shouldn’t try to catch falling knives

Last week, I had a feeling of déjà vu as I watched Steinhoff’s share price plummet. It took me back to August 2014, when African Bank crashed out of the JSE.

the darling of the market, caused a storm when the CEO, Markus

Jooste, resigned the night before the company’s results were to be released.

The results presentation was postponed and the share price nosedived.

I was concerned by the number of people who wanted to know whether they should buy Steinhoff’s falling shares.

The first question I had was: why catch a falling knife? At that point, and even now, buying in the hope of a recovery would be nothing but a gamble, simply because there isn’t enough information to allow anyone to make an informed decision.

We’ve all heard that buying low and selling high is sound investment advice, but it is advice that must be followed with care. If in doubt, it helps to have a checklist to see whether a share is good to buy or you should hold out.

There are also a few questions you should ask yourself:

● What caused the dip?

Gather all the information you can about why the stock fell. Go back a few months if need be.

If you don’t have enough information, wait a bit.

● What has the company done in response?

Wait and hear what management has to say — and any statement it issues should give details about the underlying issues for the company.

The message should be clear and help you get a better understanding of the situation. It should also map out a remedial strategy, or give you an indication that management plans to draw up such a strategy in the near future.

Scrutinise management’s proposals and ask whether they make sense for the company and benefit you as an investor.

● Is the issue with management or is it as the result of an external problem?

At times, a company’s issues are due to management’s negligence and callousness. If you think back to the Enron scandal in the early 2000s, you’ll recall that Enron was flying high until it was discovered that it was cooking its books and inflating profit numbers. BP also had an oil spill that affected the company for a few years. That was also a result of negligence on the company’s part. Management’s failure to do the right thing could be an indication that it is a bad company in which to invest. You want your money to be taken care of and for management to respect the laws and regulations that govern the sector in which they operate.

● What are regulatory bodies saying and doing?

Pay attention to progress reports from local and international regulators. The JSE will delist a company if it doesn’t comply with its rules; when there’s not enough protection for minority shareholders and if the company’s activities border on criminal.

But what happens to your shareholding once a company is delisted? When that happens, shareholders are issued with a statement reflecting the value of the share. What they get out depends on what the company does once it is delisted. If it is broken up or wound down, shareholders will get whatever is left after creditors and preferential shareholders have been paid.

Sometimes there is nothing left to pay out, so you may lose your capital altogether.

These crashes aren’t always easy to predict, which is why it’s important to diversify your portfolio.

When African Bank’s share price started to plummet, people thought they could make money if they bought the shares when they hit R1. A few hours later, the stock went all the way to zero and had to be delisted.

Having an understanding of the best- and worst-case scenario will help you make a smarter decision, although in most situations like this you’d be better off putting your money into a stock that isn’t going through such a turbulent time.

It’s easy to be caught up in a frenzy of excitement when the stock you thought you’d missed out on earlier is very cheap.

There will be plenty of time to buy that share at a lower price if the company does start to recover, but market storms like these usually require a wait-and-see approach.