Nine times out of ten falling stocks usually go lower, and buying a falling stock can have the same effect as trying to catch a falling knife: You’ll get hurt, almost every time.
However, buying quality stocks when they drop to new lows is a strategy that can yield impressive results over the long term. Although you need to do your research to avoid the falling knives.
Gulf Keystone Petroleum (LSE: GKP), Dialight (LSE: DIA), Rolls-Royce (LSE: RR) and Tate & Lyle (LSE: TATE) all recently slumped to 52-week lows. The question is, are these companies turn around plays or falling knives?
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Running out of cash
It’s no secret that Gulf Keystone is struggling to survive. The company is running out of cash fast. Jón Ferrier, Gulf Keystone’s new chief executive, has stated that unless the company starts to receive some of the $200m owed cash for oil exports soon, it is in “real trouble“.
During the same interview, published only a few days ago, Gulf Keystone’s new CEO then went on to warn that the company is “on a knife-edge in terms of our commercial position“. That’s not the most reassuring statement for investors.
That said, oil payments are supposed to have started this month, which should alleviate some pressure on the oil minnow. Still, until there’s more certainty regarding the company’s commercial outlook, Gulf Keystone should be avoided.
Disappointing results
Dialight has issued a string of profit warnings over the past 12 months and investors seem to have lost a lot of confidence in the company.
It’s easy to see why. A downturn in orders from the oil & gas industry has pulled the rug out from under Dialight. First half profits collapsed 51% year-on-year and the group’s operating margins have contracted by 60%. Management blamed higher costs and tighter margins on “operational inefficiencies” and is taking actions to streamline operations.
Nevertheless, Dialight is still highly by the market. The company currently trades at a forward P/E of 18.2, which leaves plenty of room for disappointment.
If management’s plans to cut costs don’t go to plan, or trading continues to deteriorate, Dialight’s shares could have further to fall.
Brand heritage
Rolls-Royce has issued four profit warnings in 18 months, so it’s no surprise that the company’s shares are currently trading at a three-year low.
Rolls is a complex company with a rich brand heritage, but the company’s future will depend on its ability to sell a raft of new jet engines, including the Trent 7000. Rolls is aiming to capture a 50% of the long-range passenger aircraft engine market over time.
If Rolls can achieve this target, then the group is well placed to generate returns for shareholders over the long term. A refreshed management team, led by new CEO Warren East, should help Rolls return to growth.
Looking up
Tate is another FTSE 100 constituent that’s issued numerous profit warnings during the past year. The company has been suffering as cheap Chinese competitors move in on its markets.
However, Tate’s first half trading update, released today, didn’t contain any additional bad news. Indeed, it looks as if the company now has a firm plan in place to return to growth, by targeting the speciality ingredients market.
Tate’s special ingredients business performed better during the first half of this year than in the same period last year. So, Tate seems to be making progress. And for investors who are prepared to wait for the company’s turnaround, Tate currently supports a dividend yield of 5.5%.
