Buy When Profit Drops in the Short Term
Oftentimes, when a company’s profits fall, its share price follows, and investors start to panic. Granted, a prolonged decline in profit is something to worry about as it may signal a deterioration in the company’s long-term competitiveness or a structural shift in the industry. However, if the fall is temporary or cyclical, it might be time to have a look.
Here’s an example. Premier Marketing is a Thailand-listed company that sells snacks and exports tuna. In 2016, Premier Marketing’s share price had fallen by 27% from a high of THB11.10 to a low of THB8.15. The fall in share price was due to the company’s poor 1H2016 performance — profit had decreased by 12%. It was only the second time in its listing history that Premier Marketing had reported a drop in profit. I decided to study the company’s fundamentals, understand why its profits had fallen and, most importantly, if the company could recover soon enough.
Premier Marketing produces a brand of fish snack called Taro which has a 70% market share in Thailand. As a regular visitor to the country, I personally knew that Taro is the most popular fish snack around and easily found in convenience stores and supermarkets everywhere. Later, I found out the decrease in profit was due to two issues.
First, weakening domestic consumption in Thailand was affecting Premier Marketing’s snack business and curtailed its growth. Second, sales from its tuna export business was affected by the economic slowdown in the countries Premier Marketing exported to. By understanding the situation, we determined that company was likely to recover and the issues were temporary: the economy moves in cycles and there was no evident structural shift. On top of that, Premier Marketing had a net cash position with zero debt, and a track record of paying a growing dividend and a return on equity above 20%.
At the time of our research, Premier Marketing’s share price was THB8.30. This gave us a P/E of 12.30 based on average earnings and a dividend yield of 5%. It looked like an opportunity to invest in a good company at a reasonable price, which we did. Premier Marketing’s share price is now at THB13.50 (as at 22 September 2017), giving us a 77.30% gain inclusive of dividends from just one year of holding.
So next time you notice a company reports a drop in profit and its share price falls in tandem, go and take a look. If the company’s long-term fundamentals are still good and you determine, based on thorough research, that the decline in profit is temporary, it may be a good opportunity to invest.