By Stephen Simpson, CFA, Kratisto Investing
There is really no question “if” there will be another public relations scandal that taints a publicly traded company. The only questions really revolve around "when," "how bad," and whether the next bad public relations (PR) event will create a buying opportunity for shareholders. Like most other kinds of turnaround investing, though, trading in the face of bad PR can be a high-risk/high-reward situation. Accordingly, it is a good idea for traders to do what they can to tilt the odds in their favor.
Assess the Situation Across Four Metrics
When approaching a stock that looks cheap because the company has made a very public gaffe, there are a few key constituencies to keep in mind. Ultimately, the reactions of these groups will go a long way toward separating the wounded-but-will-recover from the permanently maimed.
1. Impact on Customers
It probably seems obvious that the first place to check for fallout is among the people the company depends upon for its business. If a company alienates its customer base, and they do not come back, that company is doomed. Likewise, if a brand's cache or premium positioning is tarnished, the company may never again be able to charge similar prices. On the other hand, if customers really just do not care about the problem, it will likely not have any lasting impact.
Take the example of the tobacco industry. Most people who smoke are brand loyal to the extreme and know the product is dangerous. Consequently, it is difficult to imagine a scenario that would alienate a large percentage of the customer base enough to prompt a switch to a new brand or cause them to stop altogether. The so-called scandals that involve the tobacco companies back in the late '90s may have inflamed non-smokers, but there is scant evidence that many (if any) smokers said something along the lines of "They lied to me? That's it, I quit!"
On the other hand, a car company that fails to deal with a dangerous design flaw or quality control issue will quickly find itself in trouble. Likewise, a deadly food poisoning incident would be a serious matter to customers, sending them to other chains. (Companies balance the interests of owners, customers, and employees.)
2. Impact on Politicians
It is one thing to make customers mad enough that they abandon a company, but it is an altogether different matter when customers are outraged to the point where they pressure politicians to do something. Once politicians get involved, the cost of doing business can skyrocket. In fact, in some cases, politicians can drive a company or industry out of business entirely.
Consider the calls from some that the government should have nationalized BP plc (BP) as punishment for the Gulf oil spill in 2010. Alternatively, consider the dizzying array of consumer protection laws in the United States, laws that came about largely because companies did things that hurt people. Since the companies did not do enough (in the public’s eye, at least) to ameliorate the damage and prevent re-occurrences, politicians stepped in and said, "Since you will not fix this, we will." Not surprisingly, Congress' fixes always cost more.
That is something to keep in mind with industries like the airlines or pharmaceuticals where bad press is a little more commonplace. Do airlines risk re-regulation if they push fees too high and customer service too low? Would another crash lead to expensive new maintenance regulations? Do drug companies risk government price controls if they try to charge too much for essentials like insulin?
Whatever the case, make sure to gauge where the winds are blowing in Washington, D.C. before investing in the face of bad PR. The securities and banking industries got off relatively light, but disgruntled Congressmen basically killed legal online gambling in the US.
NEXT: More Key Considerations for Investors and Traders