Finding Winners Using the News and Dead Cats
If you are willing to take big risks on a single stock, big winners can make a real difference in achieving your goal of financial independence. So, just how do you find big winners? The key is to realize that big winners come from stocks that change price substantially over a short amount of time. In general, we are looking for events that can move a stock price by at least 10% in a single day. The three things I have seen that can do this are: earnings surprises, bankruptcies, and decisions in big lawsuits.
Unless you have insider information, there is almost no chance of predicting big events ahead of time. If you do have insider information, then trading on that info is against the law unless you are a member of congress or one of their staffers. I could easily go on a huge rant about how corrupt I think this is, so don't get me started.
However, everyone is free to act once the news has been made public and this is where dead cats come in. The joke on Wall Street is that after a big fall, even dead cats will bounce. When bad news hits a company, the first emotion is fear. The holders of the stock will sell at a big loss. During the course of this selling, the price will drop low enough that some investors will feel greed and start to buy. Thus, after a big loss, stocks tend to go through a smaller rise.
After an earnings miss, it is fairly common for a stock to drop by 10% or so. However, the smaller subsequent rise will only be a few percent or so. On the other hand, after a bankruptcy announcement or a big lawsuit loss, stocks can often drop by 50% or more. The smaller subsequent rise in these cases can be as much as 10% - 15%.
PG&E (stock ticker PCG) filed for bankruptcy after the markets closed on Tuesday, January 29, 2019. However, the CEO resigned on Sunday, January 13 and everyone knew it was only a matter of time before PG&E declared bankruptcy in order to protect itself from huge liabilities due to wildfires in Northern California. The stock price of PCG closed at $17.59 on Friday, January 11. On Monday, January 14 the stock closed at a price of $8.38. Over the next few days, the stock price continued to fall, but after that, it has steadily increased. As of market close on Tuesday, February 19, the stock price was $17.74. If you had been brave enough to buy PCG after the CEO resigned, you could have doubled your money in a little over 1 month.
In the case of PCG, one could argue that the company is not dead. As a public utility, PCG has millions of customers who rely on the company to provide gas and electricity who have no other alternative provider. Therefore, even with a bankruptcy, it is highly unlikely that PCG will be shut down. PCG will almost certainly be allowed to keep operating and make profits in the future. Keep in mind that PCG declared bankruptcy in 2001 and was allowed to operate and generate profits afterwards. While it seems unlikely that PCG will trade again near $50 (PCG closed at $47.18 on November 1, 2018) any time soon, it was highly unlikely that PCG would remain below $10.
In another case, Windstream holdings (stock ticker WIN) lost a huge lawsuit after the markets closed on Friday, February 15, 2019. Windstream was ordered to pay a hedge fund over $310 million while its last quarterly statement showed the company had less than $38 million in cash. The stock price of WIN closed at $3.37 on February 15. On February 19 (markets were closed on February 18 for President’s Day), WIN opened at $1.22 and closed at $1.31. I think that Windstream really is a dead cat and that there is a high likelihood it will undergo a bankruptcy that completely wipes out its shareholders. The interesting stock in this case is Uniti (stock ticker UNIT).
Windstream created Uniti as a Real Estate Investment Trust and transferred much of its cell tower and wired assets to it. As a result, Uniti receives the majority of its revenue from just one customer: Windstream. On Friday, February 15, 2019, UNIT closed with a stock price of $19.98. On February 19, UNIT opened at $10.87, rose to over $13 during the following hour, and then closed at $12.51. If you had been fairly aggressive, you could have bought UNIT at $11.50 and then sold it for $12.65 at some point during the day. This would have netted a 10% gain over a single day. There is almost no chance that Uniti will go bankrupt, however, there is a high likelihood that it will have to substantially reduce its dividend. So, while I think UNIT will not drop much lower, I also do not think it will rise much above its current price over the next few months.