Falling Knives

We [The Brandes Institute] examined the performance of falling knives in the U.S. stock market from 1986 through 2002. While the falling knives we identified did post a relatively high bankruptcy rate over the three-year period following their initial drop, they also outperformed the S&P 500 by wide margins. We followed up our study of U.S.-based falling knives by extending our falling knife analysis to markets outside the United States – and we concluded that non-U.S. knives also tended to outdistance their benchmarks.

Overall, we find that falling knives around the world continued to offer significant outperformance potential. Our research also yields a variety of specific conclusions:

• Bankruptcy risk was higher than normal among U.S. falling knives, but even when bankruptcies are counted, the average U.S. knife outperformed the S&P 500 substantially
• While falling knives in non-U.S. markets went bankrupt at a much lower rate than their U.S.-based counterparts, these non-U.S. knives posted similarly strong outperformance figures
• 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

[10/18/09 - new link via chucks_angels]

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[4/28/13] Your ability to maintain focus on the long term comes from experience. You go through a couple cycles where everybody else is screaming at you not to try to catch a falling knife, and then when you do so and make some money, it does wonders for you . . . and for your ability to do it next time.

—Howard Marks, Oaktree Capital [excerpt from The Art of Value Investing]