We've all picked stocks that didn't perform as well as expected. And, if you're like me, you've also held onto underwater investments for a bit longer than appropriate in hopes of a recovery.
In those cases, it's helpful to see a big red flag that lets you know that it's time to call it a day and recoup the remains of your investment. Here's one to be on the lookout for, especially when it's coming from a stock that's taken a beating recently.
What's to blame for bad results?
There are a lot of things that can cause a company's stock to go down and stay down. Many of those things are entirely external and uncontrollable, like bearish sentiment in the wider market, rising interest rates courtesy of the Federal Reserve, or rising risks from geopolitical developments. Other factors, like sales performance and profitability, are at least partially under the control of management.
At minimum, businesses have full control over their communications with investors and the public, which greatly influences their share prices. So when management exercises its capacity and obligation to communicate about a company's recent performance, especially when that performance is poor, it's often quite enlightening to see what leaders choose to credit for successes and what they blame for failures.
Take Cassava Sciences (SAVA 2.81%), for example. It's a pre-revenue biotech developing a controversial therapy for Alzheimer's disease called simufilam, currently in phase 3 clinical trials. Its stock is down by 50% in the past 12 months.
Last year, unnamed sources told Reuters that the Department of Justice (DOJ) had opened a criminal investigation into whether Cassava had misled investors by fabricating key findings of its research on simufilam. In 2021, The Wall Street Journal reported that sources had said the Securities and Exchange Commission (SEC) was investigating claims the company manipulated research results. The company said in an SEC filing two days prior to the WSJ article that "Certain government agencies have asked us to provide them with corporate information and documents. We have been cooperating and will continue to cooperate with government authorities. No government agency has informed us
that any wrongdoing has occurred by any party."
On Oct. 12, a leaked copy of an investigation by the City University of New York (CUNY) indicated that one of its faculty, who was responsible for much of the scientific research underpinning Cassava's Alzheimer's program, had allegedly committed "deliberate scientific misconduct" in at least 14 of the 31 instances investigated. That researcher's work may soon be retracted from the journals it was originally published in. Cassava's current senior vice president for neuroscience was a co-author of much of the research in question, and was also cited in the CUNY investigation.
Simufilam is Cassava's only pipeline program. If the scientific basis for its potential usefulness in treating Alzheimer's is as shaky as it currently appears to be, it would make sense to sell the stock. There is no point in owning a biotech stock if you doubt the fundamental validity of its therapeutic approach, as the risk of failure in the drug development process is high even under the best of conditions.
But rather than acknowledging serious blows to the simufilam program's credibility and charting a new course for research and development (R&D), management picked a different route. It blamed short-sellers for running a smear campaign designed to tank the company's stock price, much as it did in 2022 and 2021. While Cassava didn't accuse CUNY of working with short-sellers directly, it did claim that short selling activity surged before the report leaked, thereby insinuating the existence of collusion.
And that right there is the big red flag that investors need to fear like the plague when a stock is down. Here's why.
Taking responsibility is a good look; casting blame isn't
Short-sellers bet -- and hope to profit -- that a stock will trade for a lower price tomorrow than it is trading for today. If a stock has a higher proportion of short-selling than what's normal among its peers, it's a bearish sign, because it implies a higher level of pessimistic expectations. It's possible that shareholders on the margin will be scared into selling their stock if they notice that there's a lot of short selling going on. But investors don't start short positions without a compelling reason to do so. Indeed, the risk of shorting a stock is greater than betting it will rise because potential losses have no ceiling if the shares appreciate.
In Cassava's case, as mentioned previously, there are compelling reasons to expect that its shares will fall further. By blaming short-sellers, management is confusing cause and effect. Short-sellers can't create new problems or affect any element of a company's operations. They certainly can't force a biotech to hang its hat on discredited research. They can only position themselves to benefit from a business's headwinds or operational flaws.
Smart management teams communicate with shareholders to ensure their expectations are in line with what's actually doable, given operational constraints and external factors. In the event of worse-than-anticipated results, good management takes responsibility where relevant, and explains how it plans to work around detrimental trends and developments, even when it can't directly control them. The favorable trait to keep an eye out for is pragmatism.
In contrast, it's invariably a red flag when a management team accuses short-sellers and their supposed collaborators of being responsible for falling share prices. By incorrectly attributing blame to what they paint as outside and uncontrollable forces, they surrender the possibility of creating fruitful organizational change. And if you're a shareholder, there's nothing more frightening than leadership that's doubling down on a losing strategy.
Cassava is far from being the only offender. So be on the lookout for similar messages if one of your stocks is down.
