Yogi Berra, the quotable Yankees baseball legend who sadly died last month, would have known what to say to investors caught out by the VW scandal: “Predictions are difficult, especially about the future” was one of his best lines. Anyone holding the car-maker’s shares will know just what he meant.
Was the diesel emissions debacle predictable? No more than the LIBOR scandal to which it has been, perhaps prematurely, likened. There were good reasons not to invest in VW and other car-makers. Largely these were to do with China, where VW earns nearly half its profits and growth is slowing. The fact that it might have doctored its emissions tests was not one of them.
The lack of foresight is the first challenge for investors in a situation like this. The second is that they then have to act without the benefit of hindsight either. There are two things you need to know to determine whether VW’s shares are worth buying after losing a third of their value – the scale of the fines that will be imposed on the company and the extent of the reputational damage it will suffer.
Look at the precedents
On the first point, all you can really do is look at the precedents. The good news is that the stock market tends to immediately price in the worst case scenario. There hasn’t been a fine in excess of US$1 billion levied on a car-maker in the US so the key question now is whether VW will be fingered by regulators in any other jurisdiction. China is the most important but the company didn’t sell many of the affected cars there and standards are, anyway, lower.
Purely on the basis of the expected fines, therefore, the plunge in VW’s market value on news of the scandal seems overly prudent. The balance sheet is strong enough to take the hit. The departure of chief executive Martin Winterkorn should also clear the air.
The reputational question is much more difficult to predict. The good name of a company is much easier to destroy than to build. Gerald Ratner showed how one throwaway remark can wreck years of careful brand building. People who bought a cheap and nasty decanter may have assumed it was “total crap” but they didn’t welcome the boss telling them as much. Someone who believes they’ve paid over the odds for a car that turned out to be less green than they thought may be even slower to forget.
Simple is not the same as easy
Companies unexpectedly doing bad things is one reason why investing felt difficult of late. But it wasn’t the only reminder that simple is not the same as easy.
Another was provided by Hillary Clinton and a tin-eared former hedge fund manager who between them stuck a big pin in the nascent biotech bubble. The hedgie-turned-pharma-entrepreneur, Martin Shkreli, started it by buying an old treatment for a life-threatening parasitic infection, jacked up the price of the drug from $US13.50 a dose to $US750 and then shrugged when everyone cried foul. Presidential-hopeful Clinton waded in on Twitter, promising to stamp out what she described as “outrageous price-gouging”.
It was a reminder that companies operating in highly regulated and highly political sectors can be exposed. Stir in biotech’s sky-high valuations as investors increasingly chase anything that looks like it can provide rising earnings in a low-growth world and it was scarcely surprising that the sector should have taken a pounding. The Nasdaq biotechnology index tumbled after Clinton’s tweet.
How to avoid the next VW
So how do you avoid the next VW? How do you make sure you’re not blind-sided by the next piece of pre-election grand-standing? The short answer, sadly, is that you can’t. What you can do, however, is make sure that when you are caught in the cross-fire you live to fight another day.
VW represented about 3 per cent of the German stock market. Even if you had all of your money invested in a sensibly diversified German fund, you will only have lost around 1 per cent of your savings on VW’s decline. Assuming that Germany was a much smaller part of your portfolio, in line with its contribution to the global economy, the hit will have been commensurately smaller.
As investors, we just have to live with not knowing what’s round the corner and diversify away the risk that we crash into it. As Berra said: “The future ain’t what it used to be.”
