Great article from today's New York Times:
pril 8, 2001
Market Watch: In Stock Prices, What a Difference a Digit Makes
By GRETCHEN MORGENSON
Bottom fishers beware. When stock prices sink to single digits, the odds are that they are sunk for good.
That is the conclusion of a study by Thomas W. Watts, Internet infrastructure analyst at Merrill Lynch. Going back
to 1985, Mr. Watts studied the trading of 1,900 publicly held companies spanning the technology sector. He found
that of those companies whose stocks had fallen to single digits, only 3.4 percent rebounded to $15 or higher
within the next year. Most of those that didn't bounce back in the first year never did.
Mr. Watts said he got the idea for the study from individual investors who repeatedly told him that their former
stock market darlings, down as much as 90 percent from their highs, looked cheap.
Indeed, many investors have been doubling up on their stock positions, hoping to bring down their average costs of
ownership. "And there seems to be an irresistible lure to buying a $3 stock," Mr. Watts noted. "If it goes up $1,
that's a great return."
But the rebound that many of these investors are expecting will probably never come. As Mr. Watts pointed out,
there are several reasons for this.
First, many professional money managers, like those in charge of mutual fund portfolios, are barred by their firms'
bylaws from buying stocks under $10. That keeps a powerful group of buyers out of these shares.
And for many companies with low-priced stocks, the mere fact that their market value is low makes it difficult to
tap the stock market for money. That is because investment bankers find it much easier to raise money for a
company whose stock has rocketed in the recent past.
But the sad fact is that many of these companies have so little cash on hand to run their businesses that if the
markets are closed to them, they can very easily fail.
Many investors may be secretly hoping that their low-priced companies will be taken over by other concerns. But
Mr. Watts pointed out that so-called strategic buyers were more likely to wait until a troubled company went into
bankruptcy. At that point, the buyer could get the company's assets at even lower prices.
He said there was a chance, because technology stocks have been hit so hard in the last year, that the average
rebound rate could rise in coming months. But he does not expect it to increase significantly.
So far this year, the recovery rate is grim indeed. Of the 437 companies that became one-digit wonders in 2000,
only five have come back in 2001. That is 1.1 percent.
Mr. Watts said this may be a result of too many untested companies being brought to market during the mania. "By
electing to invest in companies at much earlier venture stages, public investors have started to experience failure
rates closer to those of the venture capital community," he said.
Companies face the best odds of rebounding during periods just after major downturns in the overall market, Mr.
Watts said, and there is no question that the market has fallen sharply in recent months. After the 1990 recession,
for example, 9 percent of low-priced stocks recovered substantially; following the Russian debt crisis in the autumn
of 1998, 5.4 percent of such shares rebounded.
But Mr. Watts added that the 1999 surge in the Nasdaq, when 11.3 percent of low- priced stocks recovered, has
distorted the historical data. Excluding that explosion, which carried many weak companies along with the strong,
the average recovery rate for the entire 15-year period would have been 2.9 percent, not 3.4 percent.
In the stock market's magical mania days, investors mistook high-priced stocks for good values. Now that these
stocks have crashed, some are making the same mistake.
Forewarned is forearmed. |
