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Falling Knives


PlanMaestro
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Saj Karsan at www.barelkarsan.com posted yesterday an interesting paper on Falling Knives:

 

http://www.brandes.com/Institute/Documents/Falling%20Knives%20Around%20the%20World%20Paper.pdf

 

I like too much what I saw. Its geography, timing and industry implications for turnaround investing jumped too easily. But I wonder if others have detected any problem with the methodology or results.

 

 

 

 

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The thing I was thinking as I read it is that stocks that are down a lot are usually down for a good reason, which is why most of them underperform, but the ones that were down for no good reason get such good returns that the group outperforms.  The best time to find stocks that are down for no good reason is when people are panicking and  there is high volatility in the overall market.  I would imagine another good time is when there is a panic in one stock or sector like the deepwater horizon incident or the bursting of the tech bubble.    Obviously the best thing is to make an independent and  correct assessment of the prospects of the business but it seems like it can also be helpful to get an idea of what is going on in the seller's mind/gut.  The other strategy would be to focus on the utilities, which  would tend to recover  more often because they have a more stable business.

 

Is that pretty much what you thought of it?

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I think the best way to think about this is there is a good price and a bad price to purchase most securities.  You can use a valuation model to estimate these prices.  I think folks spend too much time waiting for great firms to sell at good or great prices which occur infrequently.  If you realize these bargains are rare and many times are illusions (see Longleaf as an example) you should spend time valuing OK firms that are selling at cheap prices.  The one question you need to ask yourself though is is this a growing firm or one that is the victim of obsolescence from which it may never recover.

 

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