Sell the rumour, buy the fact
08 April, 2015
Many investors will have heard of the investing maxim "sell the rumour, buy the fact". The saying comes from the phenomenon where buyers push a price up in anticipation of a big news event and then (often) sell off immediately after the announcement. Examples are most often seen in technology stocks where "big" new products are rumoured to be released that will dramatically change the whole industry. Exact product details are not known, but the hype machine goes into overdrive and investors pile into the stock, sure that the new product will be a king hit. Once the details of the product are actually revealed, the reaction can go one of three ways - the product is announced and it is even better than expected, so the price goes ballistic; the product announcement is underwhelming and the share price collapses; or the product is good but only as good as expected, and the price falls.
We have seen a couple of examples of this phenomenon in the New Zealand share market recently, and one impacted a portfolio holding of ours.
The first example was Pumpkin Patch, a company that we used to own and still keep an interested eye on. Their profit result was an improvement, albeit from a low base, but it was the Chairman's comments that "interested parties" were sniffing around the company that led to its share price rallying 33%. Once the Chairman subsequently doused market speculation, confirming that buyer interest was at a very early stage and might not come to anything, the share price came back down to earth.
In the case of our erstwhile portfolio company, Kathmandu, the company warned late last year that Christmas sales might be disappointing, and followed up with a shocker earnings warning in February. We had given the company the benefit of the doubt in December, but by February with a share price some 26% lower, we started to sell our holding, having lost confidence in our ability to predict the company's fortunes with any certainty. We were not alone in our selling - Kathmandu is dual listed and a number of Australian institutions were also quick to push the Sell button. The share price hit a low of $1.39 on February 5 before rebounding 26% to $1.76 on March 19.
Why did the share price bounce, and should we have held off our selling to enjoy this bounce? Of course it would have been nice to have sold at a higher price, but our investment approach dictates that when we have lost confidence in the investment thesis of a company, we will sell immediately, and look to reinvest the proceeds in a company for which we have a higher conviction.
We watched the share price rebound after our selling, and a number of our team scratched their heads as to why, with no new information to digest, the market thought the shares were worth more? There had been some solid profit results from other retailers and that might have led some investors to think Kathmandu might redeem themselves - despite the company saying otherwise. Regardless, the company released its earnings result on March 24 saying that conditions remained tough, and the share price immediately retraced several weeks' gains.
Our approach is to ignore the rumour and act only on fact. We will get stocks wrong from time to time; there is no doubt about that. But the only thing we have to base our investment decisions on is our research. We can't buy on hope or expectation; we insist on buying on knowledge and belief. They are different things.