Catching a falling knife

[nodoodahs]

Usually it hurts, but these folks have a study that suggests the few times it doesn't hurt, pay off handsomely enough to make the whole lot worthwhile. The "falling knife" strategy is similar to the "fallen angel" strategy, except the odds of hitting the floor and/or drawing blood are higher.

http://www.brandes.com/NR/rdonlyres/5E4FE92D-B271-444F-99FD-7DBB96E9368C/0/BI_FallingKnivesAroundtheWorldPaper.pdf

In Buying the Wrong Stock for the Right Reason, we examined the performance of falling knives in the U.S. stock market from 1986 through 2002. We found that investors who never catch a falling knife could be foregoing significant opportunity: while the falling knives we identified posted a relatively high bankruptcy rate over the three-year period following their initial drop, the average knife outperformed the S&P 500 by a wide margin. A follow-up study of falling knives in markets outside the United States indicated that non-U.S. knives also appear to offer significant outperformance potential.

In this paper, we enhanced our analysis by conducting parallel reviews of U.S. and non-U.S. falling knives over the 1980 to 2003 period. For both groups of knives, we studied post-fall bankruptcy rates as well as performance versus the benchmark. In addition, we examined falling knives over time, by sector, and – for non-U.S. knives – on a country-by-country basis. Finally, we tested market capitalization and enterprise-value-to-sales ratios as possible predictors of falling knife performance.

Our research yields a variety of conclusions:
• Bankruptcy risk was higher than normal among U.S. falling knives, but even when bankruptcies were counted, the average U.S. knife outperformed the S&P 500 substantially
• While falling knives in non-U.S. markets posted a much lower bankruptcy rate than their U.S.-based counterparts, these non-U.S. knives posted similarly strong outperformance figures on average
• The information technology sector yielded a high proportion of falling knives, and these knives generally outperformed substantially; knives in the utilities sector also tended to perform strongly
• The positively skewed distribution of returns for both U.S. and non-U.S. falling knives suggests that stock selection could be critical to successful falling knife investment
• Enterprise-value-to-sales ratios could help investors identify the most compelling opportunities among falling knives
_________________
I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.